Book of Home Finance: David L. Hershman

Book
of
Home Finance
David L. Hershman
©2001 - The Hershman Group
ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system, or transmitted
by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of
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This publication is designed to present, as simply and accurately as possible, general information on the subject. It
should be noted that the information presented is not all inclusive. Processes may have altered due to rapid changes
in the industry. This publication should not be used as a substitute for referring to appropriate experts and is sold with
the understanding that the publisher is not engaged in rendering legal, accounting, or other personalized professional
service. If legal or other expert assistance is required, the services of a competent professional should be sought.
Library of Congress National Serials Data Information
Hershman, David L.
Book of Home Finance/David L. Hershman
ISBN 0-9645939-4-7
I. Mortgage Loans. II. Real Estate. III. Hershman, David L. IV. Title
ISSN 1081-6720
Printed in the United States of America

The Book of Home Finance
Introduction
The world of mortgages is certainly different than it was ten or fifteen years ago. It was
not so long ago that a real estate agent would sell a home and send the purchaser to their
community savings bank to apply for a mortgage. Qualification was never a question
and neither was the choice of mortgage products. The purchaser had a relationship with
the financial institutions which offered only one or two mortgage alternatives.
Now there are many mortgage products and institutions from which to choose. The
qualification guidelines and mortgage alternatives are increasingly more complex. To
make real estate finance even more interesting, one can apply for a mortgage with a
mortgage broker, a mortgage banker, a bank, a credit union, a savings institution or even
through your home computer!
It is clear that mortgage bankers, real estate professionals and home buyers need to be
able to navigate through this maze of real estate finance in order to be a success in
today's challenging market. This book is a step toward bringing this complex world into
perspective and focus. It will not answer all questions, but it will give a base of knowledge
so that one can master the process. Invaluable time will be saved by using the charts
which compare mortgage products, down payment formulas and qualification guidelines.
Good luck in your efforts towards mastering the world of mortgages and real estate
ownership!
Dave Hershman
Table of Contents
Chapter 1: A Home as an Investment, Tax Deduction and Inflation Hedge ................. 1
Real estate as an investment—the concept of leverage ................................................................... 2
Calculation of the tax savings of a mortgage payment .................................................................... 4
The mortgage payment as an inflation hedge ................................................................................. 6
Chapter 2: Sources of Mortgages ........................................................................................... 9

The Federal Housing Administration (FHA) ................................................................................... 9
Who is eligible to obtain FHA mortgages? ..................................................................................... 9
Types of transactions financed under FHA ..................................................................................... 10
Types of properties eligible for FHA .............................................................................................. 11
Mortgage types offered under FHA ................................................................................................ 12
Costs to obtain an FHA mortgage ................................................................................................... 13
FHA qualification requirements ...................................................................................................... 19
The Department of Veterans Affairs (VA) ...................................................................................... 21
State and local bond issues ............................................................................................................. 30
Rural Housing Service .................................................................................................................... 32
Conventional conforming mortgages .............................................................................................. 32
Conventional non-conforming ........................................................................................................ 43
Chapter 3: Types of Mortgages .............................................................................................. 47

Fixed rate/fixed payment mortgages ............................................................................................... 47
Computation of an amortization schedule ....................................................................................... 48
Fixed loan alternatives .................................................................................................................... 49
The bi-weekly mortgage ................................................................................................................. 51
Fixed rate hybrids ........................................................................................................................... 53
Balloon mortgages .......................................................................................................................... 53
Graduated payment mortgages ....................................................................................................... 54
Growing equity mortgages ............................................................................................................. 54
Temporary buydown mortgages ..................................................................................................... 55
How much does a buydown cost? .................................................................................................. 56
Lender subsidized buydowns ......................................................................................................... 58
Adjustable rate mortgages .............................................................................................................. 58
Reverse mortgages ......................................................................................................................... 68
i
Chapter 4: Qualifying For a Mortgage: Ratios and Residuals ......................................... 71
The ratio method of qualification ................................................................................................... 71
The housing ratio ........................................................................................................................... 72
The monthly mortgage payment (PITI + HOA) ............................................................................. 72
The debt ratio ................................................................................................................................. 73
The debt ratio calculation ............................................................................................................... 73
Pre-qualification using ratios .......................................................................................................... 73
Credit Scores .................................................................................................................................. 77
The residual method of qualification .............................................................................................. 79
Residual method example .............................................................................................................. 80
Chapter 5: Comparing Mortgages .......................................................................................... 85

Comparing mortgage payments over the life of the mortgage ........................................................ 85
Comparing mortgage payments for different mortgage terms ......................................................... 88
Comparing points on mortgage programs ...................................................................................... 90
Comparing cash requirements for each mortgage ........................................................................... 91
Comparing qualification requirements for each mortgage source ................................................... 92
Chapter 6: Refinancing a Mortgage ........................................................................................ 93

What is a refinance? ....................................................................................................................... 93
Why would someone want to refinance a home? ........................................................................... 94
Mortgage sources and refinancing .................................................................................................. 100
Other considerations for refinances ................................................................................................ 105
How much is it going to cost? ........................................................................................................ 106
Chapter 7: Applying and Packaging Your Loan for Approval ......................................... 109
Preparing the documentation .......................................................................................................... 109
Application ..................................................................................................................................... 112
Processing ...................................................................................................................................... 114
Processor Review ........................................................................................................................... 116
Underwriting .................................................................................................................................. 118
Chapter 8: Mortgages, Home Ownership and Taxes .......................................................... 121

Purchasing a Home ........................................................................................................................ 121
Deduction of Regular Mortgage Payments .................................................................................... 122
Tax Deductions and Refinances ..................................................................................................... 124
Rental Property Deductions ........................................................................................................... 124
Taxation Upon Sale of Residential Real Estate .............................................................................. 125
Special IRA Provisions .................................................................................................................. 127
Appendix A: Interest Rate Factors

Appendix B: Federal Withholding Tax Tables
Appendix C: Estimate of Settlement Costs of a Mortgage Transaction
Appendix D: National Real Estate Transaction Taxes and Title Insurance Costs
Glossary
ii
List of Tables
Table 1-1 Return on Investment ................................................................................................... 3
Table 1-2 Principal Reduction ...................................................................................................... 3
Table 1-3 Net Return on Investment—10 Year Holding Period .................................................... 4
Table 1-4 Net Return on Investment—Varying Holding Period ................................................... 4
Table 1-5 Rental Tax-Equivalents ................................................................................................. 6
Table 1-6 Inflation Effects on Rent and Mortgage Payments ........................................................ 7
Table 1-7 Inflation, Tax, and Principal Reduction Effects on Rent and Mortgage Payments ......... 8
Table 2-1 Refunds of One Time FHA MIP ................................................................................... 14
Table 2-2 FHA Maximum Loan Limits in High Cost Areas .......................................................... 16
Table 2-3 FHA Mortgage Insurance Chart .................................................................................... 18
Table 2-4 FHA Monthly MIP Factors ............................................................................................ 19
Table 2-5 History of VA Entitlement ............................................................................................ 28
Table 2-6 30 Year Mortgage Rate Changes/A Fifty Year History ................................................. 29
Table 2-7 HUD Estimated Median Family Income Limits ............................................................. 34
Table 2-8 A History of Conforming Mortgage Limits ................................................................... 38
Table 2-9 Private Mortgage Insurance .......................................................................................... 41
Table 2-10 Major Mortgage Source Comparisons ........................................................................... 45
Table 3-1 Annual Amortization Table—20 Year Term ................................................................. 48
Table 3-4 Fixed Rate Monthly Payments ...................................................................................... 49
Table 3-5 Comparison of Fixed Rate Mortgages ........................................................................... 50
Table 3-6 Effect of Monthly Prepayment ...................................................................................... 51
Table 3-7 Annual Amortization Table .......................................................................................... 53
Table 3-8 History of Major ARM Indices ..................................................................................... 59
Table 4-1 Interest Rate Factors ..................................................................................................... 75
Table 4-2 Mortgage Amounts for Given Payments ....................................................................... 76
Table 4-3 Mortgage Qualification by Income and Interest Rate .................................................... 78
Table 4-4 VA Family Support ....................................................................................................... 79
Table 5-1 Interest Rate Increases for Variable Mortgages ............................................................. 88
Table 5-2 Mortgage Term/Prepayment Comparison ..................................................................... 89
Table 5-3 Annual Percentage Rates .............................................................................................. 91
Table 5-4 Cash Necessary to Purchase a Home ............................................................................ 91
Table 5-5 Qualification Requirements for Mortgage Sources ........................................................ 92
Table 6-1 Months to Break Even After Refinance ........................................................................ 95
Table 6-2 Points and Refinance Savings ....................................................................................... 96
Table 6-3 Effects of Monthly Prepayment on Typical $100,000 Loan .......................................... 96
Table 7-1 Items Needed for Loan Application .............................................................................. 120
iii
List of Graphs, Worksheets, and
Figures
Graph 1-1 Median Price of Existing Homes .................................................................................. 2
Graph 1-2 Median Rent Paid in the United States .......................................................................... 6
Worksheet 4-1 Purchaser Qualification Sheet ................................................................................. 81

Worksheet 4-2 Conventional Pre-Qualification ............................................................................... 82
Worksheet 4-3 VA Pre-Qualification—Residual ............................................................................. 83
Figure 3-1 The Bi-Weekly Advantage ........................................................................................... 52

Figure 3-2 I-0 Buydown ................................................................................................................ 55
Figure 3-3 2-1 Buydown ................................................................................................................ 55
iv
A Home as an Investment, Tax Deduction and Inflation Hedge
1
A Home as an Investment, Tax
Deduction and Inflation Hedge
Security, privacy, freedom—the American Dream is to purchase a home. Ownership of property is
the bastion of capitalism. There is no doubt that owning a home is the goal of the average American today.
Why? Is it the ability not to have a landlord? Is it the freedom to stay or move? There are many emotional
benefits to home ownership. However, the cornerstones of our capitalistic society are financial in nature.
The reason we all aspire to own real estate is simply this: we desire to accumulate wealth. Time and time
again, we hear of riches built with a real estate foundation. This book focuses on the financial as opposed
to the emotional aspects of home ownership. Accordingly, this Chapter will address the financial reasons
for owning and financing a home.
Even so, we do not want to play down the importance of the psychological, rather than economic
reasons for owning a home. In 1992, the Federal National Mortgage Association (Fannie Mae) released a
survey which indicated that 78 percent of all Americans think that owning a home is a good investment.
More than one-third of these gave security and sense of permanence as the reasons for wanting to own.
There are three basic economic reasons for purchasing a home:
1. Real estate is an investment. Using the concept of leverage, we
will learn exactly why real estate constantly outperforms other
investment vehicles—even during periods of low inflation.
2. Real estate is a tax deduction. Every year it seems that Congress
opts to cut more and more tax breaks from the menu in the interests
of tax simplification and preserving the progressive nature of the
tax system. The mortgage interest deduction has suffered nicks
and scratches but has emerged as the major survivor in the world
of tax strategies.
3. Real estate is an inflation hedge. It has been several years since
double digit inflation numbers have raised their ugly heads. Even
in times of low inflation, monthly rents move upward much more
quickly than a mortgage payment.
1
Chapter 1
Real estate as an investment—the concept of leverage

Many financial experts have predicted low appreciation rates for housing in the 1990s and beyond.
For those who have dreamed of the 25% appreciation rates some areas experienced in the 1980s, these
predictions must be a major source of disappointment. In fact, most of these experts have predicted that
housing will not be as solid an investment as it has been for the past 22 years. Of course, the past 22 years
have averaged a 7% rate of annual appreciation.
Any prediction of the future is just
that—a prediction. We do not aspire to be 140,000 Median Price of $139,600
any more accurate in presenting a scenario
120,000 Existing Homes
for the future of housing appreciation in any $113,800
part of the country than the so-called eco- 100,000 $95,500
nomic experts. We feel that the best ap- $75,500

80,000
proach is to assume a low rate of apprecia- $62,200
tion to be conservative. We also feel that 60,000

$35,300
the concept of leverage has been missing 40,000 $23,000
in the experts’comparison of other invest-
20,000
ments to housing. It is the concept of le-
verage which makes housing an excellent 1970 1975 1980 1985 1990 1995 2000
investment in any inflationary environment.
What is the concept of leverage? Le-
verage is defined as the ability to control a Source: National Association of Realtors
Graph 1-1
large asset with a smaller asset. For example,
you can purchase $100,000 in real estate
using $5,000 in cash assets. You can lever-
age real estate highly because of several factors: Leverage
a. Real estate assets have a long history of appreciation, which High powered finance for everyone
means security for those institutions who would lend against
the asset.
b. There is a complex system to record ownership of property—older than the United States itself. It is
unlikely that the purchaser of real estate will be challenged by someone who is the real owner of the
property from years gone by. This is also security for the lender.
c. There are consistent national standards for qualifying purchasers of real estate. These standards reduce
the risk that a real estate loan will default and allows the loan to be easily liquidated (sold for cash) in
case the lender needs to raise capital in the future.
d. Some mortgage programs are directly sponsored, subsidized, or insured by federal and local
governments, resulting in smaller down payments than would otherwise be necessary through
conventional lenders.
Let us compare a simple example in which we invest a cash asset of $10,000 over a number of years,
either by leaving it in the bank or by purchasing $100,000 of real estate. The table assumes a 6.0% rate of
interest in the bank for a total gain of $7,908 after ten years. It also assumes a 6.0% appreciation rate for
real estate during this time period. Factored in is a $5,000 cost of purchase (closing costs) and ten percent
2
cost of liquidation (sales costs). It should be noted that, assuming the prop- Return on Investment
erty is sold after ten years, these costs are $15,000, which is more than the
original asset. Yet the gain after ten years is $64,085, or a 22.2% annual $10,000 $100,00
Years Cash Property
rate of return!
3 $1,910 $4,102
What we have developed in this Chapter is a more in-depth look at the 5 $3,382 $18,823
10 $7,908 $64,085
concept of leverage as it relates to residential real estate. What if the rate of
15 $13,966 $124,656
home appreciation slows down to 2% per year? What if you try to sell the 20 $22,071 $205,714
real estate after two years? What if the down payment is 20% of purchase 30 $47,435 $459,349
price? Generally, these rules apply: Assuming 6% rate of gain, $5,000
downpayment, $5,000 closing
a. Low rates of appreciation. The effect of leverage will lessen with lower costs, and $10,000 selling costs.
rates of appreciation. However, in the long run real estate will still
outperform savings based instruments. It makes sense that low rates of Table 1-1
housing appreciation will be accompanied by low rates of inflation,
which will also lower savings rates.
b. Holding periods. Because of the cost of real estate acquisition (figured in our examples to be ten
percent) and the cost of real estate disposition (also figured as ten percent), there must be a reasonable
holding period for gain on real estate. During periods of moderate appreciation (five to seven percent)
real estate must be held at least three to five years to be more profitable than savings accounts. Higher
appreciation rates will allow for shorter holding periods. When we consider the fact that real estate
also may serve as our home, the holding period required becomes less of an issue.
c. Increasing the down payment. Generally, the larger the down payment, the smaller the percentage
return on real estate. Remember that the concept of leverage requires that we control as large an asset
as possible with the smallest asset possible.
d. Mortgage principal reduction. In addition to the leverage principle, the gain on real estate is increased
by a reduction in the principal amount of the initial mortgage on the property. In simple terms, as one
owns a house, one builds up additional equity because each mortgage payment reduces the amount of
the principal balance outstanding. Principal Reduction
Table 1-2 shows the amount of principal reduc- 30 Year Term

tion on a $100,000 loan. In this example, the cumu- $100,000 Loan Amount
lative principal reduction after ten years would be 9% Fixed Rate Loan
$10,570. This would be added to the gain calculated Annual Cumulative Outstanding
due to leverage and appreciation, as presented in the Principal Principal Principal
previous table. The table also shows how the most Year Reduction Reduction Balance
common type of mortgage loan, the positively am- 1 $683.20 $683.20 $99,316.80
ortized mortgage, has accelerated principal reduc- 2 $747.29 $1,430.48 $98,569.52
3 $817.39 $2,247.87 $97,752.13
tion properties. That means that the amount of prin- 4 $894.06 $3,141.93 $96,858.07
cipal reduction increases with each monthly pay- 5 $977.93 $4,119.86 $95,880.14
ment. Note that the table shows the first year's re- 6 $1,069.67 $5,189.53 $94,810.47
duction is only $683, while the tenth year's payments 7 $1,170.01 $6,359.54 $93,640.46
8 $1,279.77 $7,639.31 $92,360.69
reduce the principal by over $1,500. 9 $1,399.82 $9,039.13 $90,960.87
With these concepts in mind, let's take a look at 10 $1,531.13 $10,570.26 $89,429.74
a comparison table which takes our money in the Table 1-2

bank and compares its earnings with those from a
3
Chapter 1
Net Return on Investment
purchase of $100,000 in real estate over ten
years. We have varied the appreciation rates, $100,000 Home
interest rates on savings, and down payments. With Principal Reduction and Equity Gain
Assuming a 9% Mortgage Held for 10 Years
We also assume 5% closing costs and 10%
selling costs. Thus, the total investment is the
down payment plus the 5% closing costs. The Down Payment 20% 10% 5%
Total Investment $25,000 $15,000 $10,000
net returns are then calculated from the ap- Loan Amount $80,000 $90,000 $95,000
preciation of the property, plus the principal Home Savings
paid, minus the closing costs, the selling price, Appreciation Interest
and the income which could have been re- Rate Rate
ceived had the investment been left in a sav- 2% 3% $6,758 $11,254 $13,502
3% 3% $19,250 $23,746 $25,994
ings account. That means the returns shown 4% 3% $32,883 $37,379 $39,627
are over and above what the money would 5% 5% $40,623 $47,969 $51,642
have made in the bank. 6% 5% $56,819 $64,165 $67,838
7% 5% $74,449 $81,795 $85,468
The result is an interesting comparison of 8% 6% $89,578 $98,543 $103,026
returns. Note that the returns are actually 9% 6% $110,421 $119,387 $123,870
greater when a lower down payment is used. 10% 7% $128,652 $139,380 $144,744
12% 8% $175,068 $187,714 $194,037
This becomes an enormous difference if 15% 9% $263,828 $278,559 $285,924
viewed in terms of the percentage return on
the investment. Table 1-3
Next, let's look at the impact of varying the number of years you own your home. Since you only
have to pay closing and sales costs once, you will benefit most from a longer ownership period. As table
1-4 shows, the financial benefits of longer homeownership periods are even more impressive. A long
holding period assures positive returns, even
at low appreciation rates. Net Return on Investment
$100,000 Home With Principal
Calculation of the tax savings Reduction and Equity
of a mortgage payment Gain Assuming a 9% Mortgage
and 10% Down Payment
The concept of rental equivalency
This section will focus upon the tax sav- Number of Years Held 3 5 10
ings of a mortgage payment. Recent changes Home Savings
in the tax code leave mortgages as the only Appreciation Interest
Rate Rate
major write-off still available to the average 2% 3% ($8,247) ($3,273) $11,254
citizen. Other sections of this book will focus 3% 3% ($5,095) $2,246 $23,746
upon whether a purchaser can qualify for a 4% 3% ($1,881) $7,984 $37,379
mortgage loan. This section will focus on 5% 5% $421 $12,192 $47,969
6% 5% $3,760 $18,386 $64,165
whether a purchaser can afford a mortgage
7% 5% $7,163 $24,819 $81,795
loan. We do this by comparing the present 8% 6% $10,129 $30,567 $98,543
rent payment of the purchaser with the pro- 9% 6% $13,661 $37,497 $119,387
posed mortgage payment. 10% 7% $16,747 $43,721 $139,380
12% 8% $23,620 $57,902 $187,714
We make this comparison by calculating 15% 9% $34,685 $81,764 $278,559
the rental equivalency of the mortgage pay-
Table 1-4
ment. The term rental equivalency refers to
4
the amount of the mortgage payment after the effect of taxation. A discussion of rental equivalency
should enable a real estate professional to demonstrate the concept of affordability to a first time homebuyer.
The concept can also be applied to move-up buyers because the increased mortgage payments can also
be reduced by the amount of tax savings.
Let us take an example of someone who is paying $1,000 each month in rent. Let us also assume that
the same home would cost $150,000:
Rent Owning Mortgage Payment (PITI)
$1,000 $150,000 Sales Price $1,146.59 Principal & Interest (PI)
142,500 Mortgage 150.00 Real Estate Taxes (T)
9.00% 30 Year 30.00 Homeowners Insurance (I)
58.19 Private Mortgage Insurance
$1,384.78 PITI
In this example the mortgage payment is $385 more than the rental payment of $1,000 each month.
It is natural for a prospective purchaser to say:
“I can hardly afford my rent. How can I afford $385 more each month?”
In order to answer this question, we must compare the rent payment with the mortgage payment after
the tax benefits have been calculated. In order to do this, we must answer the following:
• How much of the mortgage payment (PITI) is tax deductible?
• What tax bracket is the borrower in?
Fortunately, most of the mortgage payment carries tax benefits, because the interest and real estate tax
portions which can be deducted from one's income. The calculation is as follows:
$142,500 mortgage x 9.00% = $12,825 annual interest, or $1,069 monthly
Therefore, $1,069 out of the total PI payment of $1,147 is interest and is deductible.
Total deductible portion of payment: $1,069 Interest
150 Real Estate Taxes
$1,219
$1,219 is 88% of the total payment (PITI) of $1,385
Now that we know the deductible portion of the payment, we can determine the tax bracket of the
borrower and calculate the tax savings. Using the Federal Monthly Withholding Tax Charts in the
Appendix, we find the following:
Borrower's Income (Single): $60,000 annually, or $5,000 monthly
Borrower's Present Federal Tax: $1,378
Borrower's Income after Deduction: $3,622 ($5,000 minus $1,378)
Borrower's New Federal Tax: $936
Tax Savings: $442
Rental Equivalent: $1,385 Total Mortgage Payment
Tax Savings: (-) 442
Rental Equivalent: $ 943
Actual Rent on Same Property: $1,000
5
Chapter 1
A few things to note on the Rental equivalency

above calculations: Rental Tax-Equivalents
1. There are also state and local Assuming married filing jointly, no standard deduction,
and 85% of PITI is deductible
tax savings for most
borrowers. They are not Total Mortgage Payments (PITI)
shown because many times Monthly
Income $800 $900 $1,000 $1,200 $1,500 $2,000 $2,500
the borrower will need the
$2,000 $698 $785 $873 $1,047 $1,309
deductibility of state taxes $3,000 $696 $783 $870 $1,045 $1,307 $1,743 $2,179
paid to exceed the standard $4,000 $610 $686 $762 $915 $1,177 $1,613 $2,049
deduction given to tax $5,000 $610 $686 $762 $914 $1,143 $1,524 $1,919
payers who do not itemize $6,000 $610 $686 $762 $914 $1,143 $1,524 $1,905
$7,000 $610 $686 $762 $914 $1,143 $1,524 $1,905
deductions. Those who do
$8,000 $589 $663 $738 $891 $1,119 $1,500 $1,881
not have enough itemized $9,000 $589 $663 $737 $884 $1,105 $1,473 $1,851
deductions to reach the
Table 1-5
standard deduction without
the mortgage payment will
not fully realize the tax savings for mortgage deductibility. Eliminating the analysis of state and local
tax savings minimizes this effect.
2. There are additional savings for homeowners. The portion of the principal and interest payment
which is not interest ($1,147 PI - $1,069 I) is principal which goes to pay down the loan. This is
equity the homeowner is building up even without housing appreciation—a forced savings plan. In
this case the rental equivalency with the additional factor would be $943 minus $78, or $865. Yes,
owning can be cheaper than renting--even using a higher-than-market interest rate such as 9.0%!
In order to save you the steps of these complex calculations, we have devised a chart which calculates
the rental equivalency of mortgage payments. The chart assumes that 85% of the typical mortgage
payment will be tax deductible. It also assumes the tax bracket of a married couple with no children. The
savings for single individuals will be slightly larger. You can use the table to extrapolate to other
mortgage payments. For example, the tax savings for a $950 mortgage payment would be one-half of
the difference between $900 and $1,000.
The mortgage payment as an inflation

hedge Median Housing Costs
Paid By Renters
We have discussed the investment aspects of a home purchase; $600 $579
clearly the use of leverage causes real estate to be a superior in- $487
$500
vestment at any level of appreciation. The concept of rental equiva- $424
lency makes the investment affordable in the short run. But what $400
$364
about the affordability of a home in the long term? How does the $300
home stack up against renting five, ten, and twenty years from $200
now? As time goes on, home ownership becomes more and more
1985 1989 1993 1999
affordable because a home is an inflation hedge.
What is an inflation hedge? We all know what inflation is. It Source- U.S. Bureau of the Census
is the tendency for expenses to rise over time. We know that rent Graph 1-2
6
is subject to inflation. If your present rent payment is $800, a 5% rate of inflation would make the pay-
ment $1,303 in ten years. A hedge is an instrument of financial protection. Sophisticated investors protect
their investments from erosion by using hedges. For example, someone holding a large stock portfolio
may purchase futures, betting that the stock market will go down. If we then have a stock market crash,
the person can offset the loss in the value of his stocks with the gain in the futures. An inflation hedge
protects one against future costs of inflation. The reason
for this is simple—a mortgage payment resists inflation.
A Typical Mortgage Payment
Why does a mortgage payment resist inflationary pres- $100,000, 30 Year Mortgage at 9%
sures? Because the largest portion of the mortgage pay- Principal and Interest (P&I) $805
ment is the loan repayment (P&I). (Note: The payment on Real estate taxes 160
adjustable rate mortgages may increase independently of Homeowner’s insurance 35
Total PITI $1,000
inflation.) The remainder of the payment will be subject to Portion subject to inflation $195
inflation. Specifically, real estate taxes, homeowners insur- Percentage subject to inflation 19.5%
ance, and association dues will tend to move up with infla-
tion. However, since these are only a small portion of the
payment, the overall payment will not increase as fast as rent.
In the example, only $195.00 or 19.5% of the total mortgage payment is subject to inflation. We will
use 20% as an even number. This will reduce any effective inflation by a factor of five, i.e., an inflation
rate of 5% will become 1%. In other words, the rent payment will move up at a speed of five times the
amount of the mortgage payment. Let's see what the ef-
fect is on long term numbers. Inflation Effects on Rent and Mortgage
Payments
Using Table 1-6, we can see that even low rates of
inflation (3% to 4%) will cause the mortgage payment Assuming 20% of mortgage is subject to
inflation
to become virtually equal to rent in ten years time. These
$1,000 Rent $1,400 Mortgage
are conservative measures; the average inflation rate in
Inflation After 5 After 10 After 5 After 10
the United States for the period from 1978 to 1999 has Rate Years Years Years Years
been over 4.0%.1 3% $1,159 $1,344 $1,443 $1,486
4% $1,217 $1,480 $1,457 $1,516
Our analysis of inflation hedging is only partially 5% $1,276 $1,629 $1,471 $1,546
complete. We have merely compared the actual payment 6% $1,338 $1,791 $1,486 $1,577
increases over a period of time in accordance with vari- 7% $1,403 $1,967 $1,501 $1,609
8% $1,469 $2,159 $1,516 $1,641
ous imputed inflation rates. We have not factored in the 9% $1,539 $2,367 $1,531 $1,673
effects of tax deduction and principal reduction of the 10% $1,611 $2,594 $1,546 $1,707
mortgage. In ten years, the rent payment is still projected 11% $1,685 $2,839 $1,561 $1,740
to have no tax benefit. Table 1-7 repeats the same chart, 12% $1,762 $3,106 $1,576 $1,775
13% $1,842 $3,395 $1,592 $1,810
only this time we are reducing the mortgage payments 14% $1,925 $3,707 $1,607 $1,845
by the amount of the federal tax benefit and the princi- 15% $2,011 $4,046 $1,623 $1,881
pal portion of the P&I payment.
Table 1-6
1
U.S. Department of Labor, Bureau of Labor Statistics
7
Chapter 1
Inflation, Tax, and Principal Reduction

Effects on Rent and Mortgage Payments
Assuming $120,000, 30 year mortgage at 9%
Interest, with 20% of mortgage subject to
inflation, real estate taxes starting at $150 per
month
$1,000 Rent $1,400 Mortgage
Inflation After 5 After 10 After 5 After 10
Rate Years Years Years Years
3% $1,159 $1,344 $1,052 $1,055
4% $1,217 $1,480 $1,066 $1,087
5% $1,276 $1,629 $1,080 $1,122
6% $1,338 $1,791 $1,095 $1,161
7% $1,403 $1,967 $1,110 $1,203
8% $1,469 $2,159 $1,126 $1,249
9% $1,539 $2,367 $1,142 $1,298
10% $1,611 $2,594 $1,160 $1,352
11% $1,685 $2,839 $1,177 $1,411
12% $1,762 $3,106 $1,196 $1,474
13% $1,842 $3,395 $1,215 $1,543
14% $1,925 $3,707 $1,235 $1,617
15% $2,011 $4,046 $1,255 $1,698
Table 1-7
8
Sources of Mortgages
2
The Federal Housing Administration (FHA)
The Federal Housing Administration has long been a player in the mortgage industry. The Federal
Housing Administration is a Federal Agency within the Department of Housing and Urban Development.
The loan program was created in 1934 to assist home buyers in acquiring property with small down
payments. It is important to note that under the most prevalent mortgage program, FHA does not lend
money. Lenders are given protection against default2 by the borrower. This protection is in the form of
Mortgage Insurance, and FHA is considered an insurance program. An FHA borrower actually pays for
this insurance and these insurance premiums are called Mortgage Insurance Premiums, or MIP. Simply
stated, FHA mortgages are mortgages which are made by private lenders but are insured by the Federal
Government through premiums which are paid for by the users. Having insurance provided by the Fed-
eral Government enables the program to offer lower down payments, and allows more liberal qualifica-
tion standards than comparable private mortgages. The lenders actually can approve the mortgages for
FHA under the Direct Endorsement Program.3
Who is eligible to obtain FHA mortgages?

Any borrower of legal age can participate in the FHA Mortgage Program. Citizenship is not required,
though physical evidence of a social security number and picture identification must be presented at loan
application. There are no income restrictions, however maximum mortgage limits ensure that the program
will serve primarily lower and middle income homeowners.
Two or more borrowers, or co-borrowers, can finance a house under the FHA program. These co-
borrowers need not be related, but they must have a family type relationship if one of these co-borrowers
does not occupy the house. In this case the co-borrower is defined as a non-owner occupant co-borrower.
2
In this context, default simply means non-payment of the mortgage by the borrower. Technically, when a mortgage is more than 30
days past due, it is in default. The vast majority of notes carry provisions of a late payment penalty if the mortgage is more than 15
days late (the first 15 days is called a grace period.) The 30 day period is not in addition to the 15 day grace period, rather it includes
the 15 days so that the total is 30 days.
3
When approved under the Direct Endorsement or DE program, the section of FHA would be referenced as 703b, rather than 203b
(734c, not 234c, for condominiums). Participation in the direct endorsement program also allows the utilization of staff appraisers to
appraise properties for FHA mortgages. Staff appraisers are employees of the mortgage company as opposed to independent FHA fee
panel appraisers.
9
Chapter 2
FHA currently limits one FHA mortgage per borrower which can be outstanding at any one time.
Prior to 1992, each borrower was limited to one high balance (defined as above 75% LTV) FHA mortgage
outstanding at one time. Currently, there are exceptions to the one FHA mortgage rule for hardship situa-
tions (for example transfers in which the home currently owned and financed by FHA cannot be sold, new
homes mandated by an increase in family size, or home being vacated will be occupied by a co-mortgagor
or such a diverse situation). In the price range of FHA mortgages, borrowers retaining more than one
FHA mortgage is not common—especially now that assumptions are restricted to owner occupants.
Types of transactions financed under FHA

FHA finances the following types of transactions:
• Owner occupied purchase transactions. (203b) The vast majority of FHA financing is for purchases of
homes in which the purchaser is financing his/her primary residence (Must be occupied within 60
days of settlement). Investors cannot finance purchases through FHA and the financing of second
homes is restricted to hardship situations. FHA is prohibited from insuring a mortgage on a second
home which is a vacation property.
• Owner occupied rate reduction4 refinance transactions (203b). Homeowners can refinance their current
mortgage through the FHA program. If the homeowner currently has an FHA mortgage on the property
and the new FHA mortgage will result in a lower payment, the homeowner can participate in the FHA
Streamline, or FHA Rate Reduction, refinance program. This program requires no income re-qualification
as long as there is a good mortgage repayment history. The Streamline program also requires no
appraisal if the original mortgage amount is not increased to include the costs of the refinance. Under
the FHA Streamline Program a homeowner who no longer lives in the property but has an FHA
mortgage can obtain an FHA mortgage with a lower payment through a refinance as long as no
closing costs are financed.
• Owner occupied cash out refinance transactions (203b). An existing homeowner can refinance to take
cash out or pull equity out up to 85% of the value of the property. In other words, if a homeowner had
a property which was worth $100,000 and a present mortgage of $50,000, the homeowner could
obtain a new mortgage of $85,000. This would give the homeowner $35,000 ($85,000 minus $50,000)
in cash, less the costs of the refinance transaction. Cash out refinance transactions are limited to
homeowners who have had their present mortgage for at least six months. This is also referred to as
six months seasoning.
• Rehabilitation mortgages (203k). These mortgages are used for the acquisition of properties which
need repairs or rehabilitation. The cost of rehabilitation can be included in the mortgage amount with
little or no down payment for first time home buyers. The lender lends enough money to acquire the
property and then escrows5 the money necessary to complete the repairs—the estimate of which is
determined by plans submitted at the time of loan application. The repair money is then released in
increments, or draws, as the work is accomplished in stages. Investors previously could finance
properties under this program with a larger down payment, but in October 1996 FHA declared a
moratorium on the financing of investor properties using 203k.
• Qualified veterans (203b Vet). FHA finances purchases for qualified veterans. This program does not
differ from any other FHA program except that the down payment may be up to $750 less than for
4
A rate reduction refinance transaction is a refinance of only the existing mortgage balance and allows an increase of the new
mortgage amount over the existing mortgage balance only to finance, or roll in, the closing costs of the refinance transaction.
5
The term escrow refers to holding money aside in a third party account.
10
typical FHA mortgages (the 97.75 and 98.75 limits do not apply). The program is open to all veterans,
but not to active military personnel. A Certificate of Veterans Status from the Department of Veterans
Affairs must be obtained.
• Assumptions. FHA mortgages closed before December 1, 1986 are fully assumable by owner occupants
and investors for a $125 fee. FHA mortgages closed from December 1, 1986 to December 14, 1989
are fully assumable by owner occupants but investors must pay down to 75% LTV. Mortgages closed
after December 15, 1989 require buyer qualification for a fee of $500. Investors cannot assume these
mortgages.
Types of properties eligible for FHA

Generally, the FHA program includes all properties which contain up to four units. Condominium
Projects and Planned Unit Developments (PUDs) must be approved by FHA in order for properties within
the developments to obtain FHA financing. For new homes, FHA must approve the plans and specifica-
tions of the home to be financed. If the plans and specifications of the new home are not approved by
FHA, the home must be covered under an FHA approved warranty program of at least one year, or a
minimum down payment of 10 percent must be made on the transaction. FHA does not finance farms and
the land upon which the property is located cannot exceed what is necessary for livability.
The issue of condominium project approval is the most complex property issue associated with FHA
mortgages. In general, condominium projects must adhere to the following rules:
• 70% of the project must be sold (the developer cannot hold more than 30% of the project, whether the
project is complete or not);
• 100% of the common areas must be complete, or there must be approved financial protection such as
bonds or escrows;
• 51% of the units must be the primary residences of the occupants (no more than 49% investor owned
units). FHA local regions have the authority to increase this requirement to 70%;
• The legal documents must be in compliance with local, state and federal laws, with a specific reference
as to compliance with FHA regulations;
• The annual budget and insurance coverage must be acceptable to FHA;
• There will be a site inspection by FHA to determine the acceptability of the facilities of the project (for
example, is the roof in good maintenance?);
• If a new project, the sales must be governed by a Fair Housing Plan;
• If a conversion from rental units has occurred, the units must have been converted for at least one year
before FHA lending can take place (except for existing tenants);
• An environmental assessment of the project must take place;
• If the project is built in legal phases, compliance may take place phase-by-phase;
• If the project is approved by the Department of Veterans Affairs (VA), an abbreviated approval process
may be acceptable, but the 51% owner-occupancy and 70% presale requirements will still stand.
• In August of 1996, FHA issued procedures for condominium units to be approved on a spot basis
when it appeared that the association could not make changes in the legal documents. Projects are
limited in the number of units which can be "spot" approved.
11
Chapter 2
FHA appraisals are called conditional commitments and lenders can hire staff appraisers (appraisers
who are employed by the mortgage company) to issue these conditional commitments. These appraisals
are good for six months, and approvals issued under these are called firm commitments, which expire
when the conditional commitments expire. A blanket appraisal can be accomplished for a new subdivi-
sion and this is called a master conditional commitment, or MCC. In this case, FHA approves the plans
and specifications for each model in the subdivision and a final inspection is accomplished when each
home is completed. FHA regions no longer approve builders within a particular jurisdiction .
If the lender is Direct Endorsement, which means the lender approves FHA mortgages without send-
ing the mortgage to FHA for the decision, the designated appraiser sends the appraisal directly to the
lender, who issues the conditional commitment. Appraisers who are approved by FHA to issue appraisals
are said to be part of the HUD Appraisal Roster. In late 1994, FHA approved rules to allow lenders to
choose their appraiser from the roster without employing a staff appraiser.
In 1999 FHA implemented new appraisal rules designed to increase the accuracy and thoroughness of
FHA Appraisals. The Valuation Condition (VC) form filled out by the appraiser clearly indicates areas
which must be inspected - including potential hazards, Mechanical Systems, roofs, foundations and more.
In addition, any deficiencies must be noted in a Summary Report prepared for the purchaser.
Mortgage types offered under FHA

The FHA Mortgage Program offers several alternative types of mortgage instruments:
• Fixed rate mortgages. FHA will insure fixed rate mortgages which carry anywhere from a 15 to 30
year term, though the 30 year fixed mortgage is by far the most prevalent FHA financing instrument.
It is typical for FHA fixed rate mortgage pools to be securitized and sold through GNMA, which is
also a Division of HUD. These securities are normally priced in increments of one-half of one percent.
Therefore, FHA fixed rate mortgages are more readily available in these increments (for example;
8.0% or 8.5%). Until November 30, 1983, FHA published an interest rate ceiling which was set in
tandem with the VA maximum interest rate. On that date, FHA deregulated the interest rate, and the
rate and discount points became negotiable between the borrower and the lender. At that juncture,
the borrower was eligible to pay discount points directly for the first time.
• Fixed rate buydowns. FHA allows the temporary buydown of FHA fixed rate mortgages. Qualification
is allowed at no more than 2.0% below the note rate of the mortgage, and increases are limited to no
more than 1.0% each year. GNMA requires FHA buydowns to be placed in a different pool (called a
GNMA II pool). These pools allow mixed yields, which enables the note rate of the mortgages to be in
increments of one-eighth of one percent (for example, 8.0% and 8.125%). Unfortunately, the prices
of these securities are lower than GNMA I pools, so the price of the FHA mortgage with a buydown
will be greater than a comparable FHA fixed rate mortgage, before considering the cost of the buydown.
Typically the extra cost can be as much as one point.
• Adjustable rate mortgages (251). FHA annually insures a limited amount of one year adjustable rate
mortgages with caps of 1.0% each year and 5.0% over the life of the mortgage. The down payment
and qualification guidelines mirror those which are in place for FHA fixed rate programs. As of
March of 1998 FHA ARM applicants must qualify at the start rate plus 1.00% if the LTV is 95% or
greater. The volume of adjustable rate mortgages which FHA can insure are allocated through guidelines
set up through Congress. FHA adjustable rate mortgages are usually available in one-half of one
percent increments.
12
• Graduated payment programs (245). The FHA graduated payment program is a series of GPM mortgages
which feature lower starting payments that do not cover the interest accumulated during the early
years of the mortgage. This low payment creates negative amortization in the early years of the mortgage
and the mortgage balance increases until the payments become large enough to reverse the trend.
Higher payments in the later years of the mortgage serve to increase the rate of payoff so that the
mortgages pay off during a normal 30 year term. There are five FHA 245 payment plans which vary
as to down payment required, starting payment, and rate and length of increases. The down payments
are greater than those required for typical FHA mortgages because the mortgage balance on an FHA
245 can never exceed the beginning balance of a typical FHA mortgage. The FHA 245 Plan III is the
most popular because it has the lowest starting payment. Of course, it also requires the largest down
payment and has the steepest payment increases.
FHA 245 AVAILABLE PLANS
Plan I—Payment Increases 2.5% annually for 5 years
Plan II—Payment Increases 5% annually for 5 years
Plan III—Payment Increases 7.5% annually for 5 years
Plan IV—Payment Increases 2% annually for 10 years
Plan V—Payment Increases 3% annually for 10 years
Interest rates are available in increments of one-half of one percent but are one-quarter of one percent
higher than typical FHA fixed rates. For example, if an FHA fixed rate is 8.0%, the comparable FHA
245 rate would be 8.25%.
Not much effort will be devoted to analyzing such a complex program because the advent of the FHA
adjustable rate program and wide availability of FHA temporary buydowns have drastically cut down
of the popularity of the GPMs. These newer alternatives achieve a lower starting rate without the
larger down payment and negative amortization which are associated with the FHA 245 programs.
• Reverse mortgage program (255). Home Equity Conversion Insurance provides equity-rich elderly
homeowners with periodic payments to help them meet living expenses while they remain in their
homes (see Chapter 3).
Costs to obtain an FHA mortgage

This section will cover costs of obtaining an FHA mortgage that are unique to the FHA program, as
opposed to our later section, which will examine all costs of obtaining a mortgage: paid by the borrowers.
This is done by adding these closing costs to the sales price and determining an acquisition cost:
• FHA mortgage insurance. FHA mortgage insurance, typically referred to as MIP, is the one closing
cost which is unique to FHA mortgage programs. Every FHA mortgage must have mortgage insurance,
FHA Maximum Loan-To-Value

$50,000 or less $50,000 to $125,000 Over $125,000
Low Cost States 98.75% 97.65% 97.15%
High Cost States 98.75% 97.75% 97.75%
Required downpayment is 1.25% to 2.85%, depending upon the sales price.
Borrower must invest at least 3.0% in the transaction (including downpayment accourding to maximum LTV
above). The 3.0% cannot include discount points or prepaids. Seller can contribute up to 6.0% without
affecting loan amount (3.0% must still be invested).
Low Closing Cost States: Arizona, California, Colorado, Guam, Idaho, Illinois, Indiana, New Mexico, Nevada,
Oregon, Utah, Virgin Islands, Washington, Wisconsin, Wyoming
13
Chapter 2
regardless of the amount of the down payment. FHA collects mortgage insurance up-front and monthly,
except for condominiums (Section 234C), which are only subject to monthly insurance costs.
a. Up-front premium. Beginning January 1, 2001 the amount of the up-front mortgage insurance
was lowered to 1.50% of the mortgage amount for 30 year and 15 year mortgages. The amount of
FHA up-front mortgage insurance premium was 3.0% (2.0% for 15 year mortgages) for Federal
Fiscal Years 1993 and 19946. This premium dropped to 2.25% of the mortgage amount starting
with FHA mortgages closed on or after April 17, 1994. The entire amount of this MIP can be
financed into the loan amount. In other words:
• If the FHA loan amount is $100,000 (base mortgage amount);
• The mortgage insurance premium would be $1,500 ($100,000 x 1.50%);
• The mortgage amount including MIP would be $101,500 ($100,000 + $1,500)
(mortgage amount including MIP).
What really happens during an FHA mortgage transaction is that the borrower owes FHA a lump
sum mortgage insurance premium. The lender making the FHA mortgage will actually lend the
money for the premium to the borrower and send the money to FHA so that the mortgage will be
insured. (FHA issues a mortgage insurance certificate, or MIC, to the lender which must be sent to
GNMA as proof of insurance so that the mortgage can be included with other mortgages in a
pooled mortgage security sale.) If the mortgage is paid off before maturity, either through sale or
through prepayment, FHA must refund the unused up-front MIP. The amount of Mortgage Insurance
to be refunded will decline each year (See Table 2-1).
b. Monthly mortgage insurance. There are two types of monthly mortgage insurance for FHA mortgages:
• Condominiums. Since condo-
miniums are not subject to up-front REFUNDS OF ONE TIME FHA MIP7
MIP, the monthly cost is stable at MIP Refunds: HUD will refund to the mortgagor unearned
.50% over the life of the loan. Mortgage Insurance Premium (MIP) if the contract of
insurance is terminated before maturity of the mortgage.
• All other properties. The amount of
monthly MIP and the length of the Listed below are percentages of one-time Mortgage
premium depends upon the amount Insurance Premiums (MIP) refunded to FHA mortgagors
when contract insurance is terminated (5 year schedule in
of the down payment, or the loan- effect for loans closed after January 1, 2001).
to-value. Keep in mind that FHA
loan-to-values would be based upon Contract of Insurance Percentage of
Terminated At the MIP Refunded
the mortgage amount divided by the
End of Policy Year 7 Years 5 Years
acquisition cost, as opposed to the
1 90% 75%
classic definition of loan-to-value
2 80% 55%
which would be the mortgage
3 60.2% 35%
amount divided by the sales price.
4 38.6% 17.5%
As stated previously, the acquisition
5 21.8% 0%
cost is the sales price in addition to
6 8.4%
any allowable closing costs which are
7 0%
actually paid by the borrower. There
Table 2-1
6
The Federal Fiscal Year runs from October 1 to September 30th. For example, the 1993 Federal Fiscal Year runs from October 1, 1992 to September
30, 1993.
7
The refund of unused MIP must be differentiated from a refund of distributive shares. In the latter case, all FHA mortgages of a certain time period
are put into pools by FHA. If there is residual money which remains at the end of the life of the pool, the money must be refunded to the borrowers. Of
course, this may be 20 years after the original mortgages were created.
14
is no current provision for removing the premium once the loan-to-value drops through prepayment
excepting for loans closed after January 1, 2001. For 30-year mortgages closed after January 1,
2001, the premium is eliminated when the loan balance is 78% of the original purchase price,
provided the premium has been paid for at least five years. Tables 2-3 and 2-4 summarize up-front
and monthly MIP for FHA mortgages and give us examples of how to calculate the monthly
premiums.
FHA streamline refinances. The one exception to FHA mortgage insurance rules would be FHA
streamline refinances. As discussed previously, FHA streamline refinances are simplified refinances
which allow the borrower to lower the rate on current FHA mortgages with minimum
documentation. If the current mortgage was already subject to up-front MIP and no monthly MIP
(Which means that it was closed before July 1, 1991 at a time when FHA required 3.8% up-front
but no monthly MIP), the borrower would get a refund of his/her unused premium which would
be applied to a new 1.5% premium. In addition the borrower would not be subject to the monthly
MIP which was put into effect before the borrower's FHA mortgage was originally closed.
In other words:
- Original Base Mortgage Amount: $100,000;
- Original Mortgage Amount with MIP: $103,800;
- New Base Mortgage Amount $102,000 (rolling in closing costs);
- MIP Refund From Previous Mortgage: $1,000;
- New MIP: $102,000 x 1.5% = ($1,530 - $1,000 refund) $530.
This exemption to the monthly MIP requirement would not carry forward for any subsequent
streamline refinances.
• Non-allowable FHA closing costs. While there are no other unusual costs associated with procuring
an FHA mortgage, there are a few other rules which are interesting to note:
1. The borrower may not pay certain miscellaneous lender fees, for example: tax service,
underwriting fees, etc. If these fees are charged by the lender, the seller must incur these costs
at closing. Since the lender normally discloses these fees to the purchaser at loan application,
the seller may very well be surprised by his/her liability for these charges at the settlement
table. The lender cannot charge these fees on an FHA refinance because there is no seller
participating in the transaction.
2. The seller is not allowed to contribute more than 6.0% of the sales price towards the borrower's
closing costs. Allowable seller contributions include: discount points, prepaids, closing costs,
and funds toward a temporary buydown. Any contributions over the six percent limit decrease
the sales price as a basis for figuring the maximum FHA mortgage amount (in effect, this
increases the down payment to the purchaser).
3. Grant Programs. FHA allows the downpayment to come from a grant from a non-profit agency
as long as the borrower invest 1.0% of their own money in the transaction. In one such matter,
(Nehemiah), the seller contributes 4.0% of the sale price to the agency (Nehemiah) which
grants 3.0% to the purchaser.
Continued on page 18
15
Chapter 2
NATION AL FHA MAXIMUM LO

TIONAL AN LIMITS
LOAN
Percent of
Conforming
1 Unit 2 Units 3 Units 4 Units Limits
Base Loan Limits: $132,000 $168,936 $204,192 $253,776 48%
Maximum High Cost: $239,250 $306,196 $370,098 $459,969 87%
Nor theast
Northeast
Connecticut Lowell 239,250 Nassau-Suffolk 237,500
Bridgeport $229,900 Pittsfield 156,750 New York/NJ
Danbury 229,900 Springfield 170,362 SMSA 239,250
Hartford 197,621 New Hampshire Rochester 134,900
New Haven 229,900 Manchester $239,250 Syracuse 132,000
New London 170,362 Pennsylvania
Stamford 229,900 New Jersey
Atlantic/ Allentown $132,000
Waterbury 229,900 Harrisburg 132,000
Cape May $168,150
Delaware Bergen 233,605 Philadelphia 158,650
Wilmington $155,800 Middlesex 222,965 Pittsburgh 132,000
Maine Newark 239,250 Scranton/Wilkes 132,000
Portland $152,362 Trenton 187,150 York 132,000
Portsmouth 152,362 New York Rhode Island
Massachusetts Albany $137,275 Providence $170,953
Boston $239,250 Binghamton 132,000 Warwick 170,953
Brockton 239,250 Buffalo 132,000 Vermont
Lawrence 239,250 Dutchess 173,850 Burlington $154,304
Southeast/Car ib
Southeast/Carib bean
ibbean South Carolina
Columbus 137,750 Charleston $157,700
Alabama Columbia 132,000
Birmingham $140,600 Savannah 132,000
Mobile 132,000 Tennessee
Tuscaloosa 133,000 Kentucky Knoxville $132,000
Lexington $133,746 Memphis 153,425
Arkansas Louisville 180,405 Nashville 193,800
N. Little Rock $153,425
Louisiana Texas
District of Columbia $234,650 Baton Rouge $132,000 Austin $159,600
VA/MD/WVA MSA New Orleans 153,900 Dallas 156,750
Florida Maryland Ft. Worth 154,850
Daytona Beach $132,000 Annapolis $189,905 Galveston 145,300
Ft. Lauderdale 144,590 Baltimore 189,905 Houston 139,650
Jacksonville 132,000 Mississippi Lubbock 132,000
Miami 138,985 Jackson $138,700 San Antonio 132,000
Naples 171,000 Virginia
Orlando 132,000 North Carolina
Asheville $133,000 Norfolk/
St. Petersburg/ VA Beach $209,618
Tampa 132,000 Charlotte 148,105
Fayetteville 133,000 Richmond 151,953
Tallahassee 132,000
West Palm Beach 133,570 Greensboro 147,250 Virgin Islands $187,300
Raleigh-Durham 171,380 West Virginia
Georgia Winston Salem 147,250 Charleston $145,800
Atlanta $176,605 Puerto Rico
San Juan $166,363
Table 2-2
16
Midwest
Idaho Kansas North Dakota
Boise City $134,995 Topeka $132,000 Fargo $132,000
Blaine City 239,250 Wichita 132,000 Grand Forks 132,000
Illinois Michigan Ohio
Chicago $228,000 Ann Arbor $177,650 Akron $147,250
Springfield 132,000 Detroit 165,775 Cincinnati 145,350
Flint 136,800 Cleveland 221,006
Indiana
Lansing 141,075 Columbus 191,425
Bloomington $132,905
Minnesota Dayton 149,530
Fort Wayne 132,000
Indianapolis 165,300 Minneapolis/ South Dakota
South Bend 132,000 St. Paul $173,755 Rapid City $132,000
Rochester 137,655 Sioux Falls 138,302
Iowa
Cedar Rapids $132,000 Missouri Wisconsin
Des Moines 133,000 Kansas City $164,350 Green Bay $132,000
Iowa City 134,900 St. Louis 142,050 Madison 147,250
Nebraska Milwaukee 151,050
Lincoln $132,000 Racine 132,000
Omaha 139,270
West
Colorado Oregon
Alaska
Boulder $239,250 Eugene $134,900
Anchorage $ 203,700
Colorado Springs 194,102 Portland 175,750
State 190,000
Denver 239,250 Salem 133,000
Arizona Ft Collins 175,750 Utah
Phoenix $142,500 Garfield 190,000 Provo $161,500
Tucson 132,000 Summit 218,405 Salt Lake City 155,800
California Hawaii
Bakersfield $140,500 Honolulu $284,810 Washington
Fresno 146,550 Maui County 204,250 Seattle $223,250
Los Angeles 228,000
Montana Spokane 132,000
Long Beach 228,000
Billings $132,000 Tacoma 161,453
Modesto 154,950
Nevada Olympia 147,250
Oakland 239,250
Orange County 239,250 Las Vegas $134,900 Wyoming
Sacramento 188,100 Reno 153,900 Cheyenne 132,050
Salinas 239,250 New Mexico
Santa Barbara 239,250 Albuquerque $146,300
San Bernadino 179,050 Santa Fe 234,503
San Francisco 239,250
Oklahoma
San Diego 239,250
Oklahoma City $132,000
San Jose 239,250
Tulsa 132,000
San Luis 237,405
Santa Cruz 239,250
Santa Rosa 239,250
Vallejo 228,000
Ventura 239,250
Note: This chart represents a sample of major metropolitan areas designated high cost areas and published by FHA
Central office as of February of 2001. It does not represent all high cost areas designated by FHA at that time. Re-
gional FHA offices may publish increased limits before the FHA Central office.
Table 2-2 (Continued)
17
Chapter 2
FHA MORTGAGE INSURANCE CHART
LOAN-TO-VALUES
FISCAL YEARS UP FRONT MIP BELOW 90% 90% TO 95% ABOVE 95%
1991 & 1992 3.8% .50%-5 Yrs. .50%-8 Yrs. .50%-10 Yrs.
FY 1993 until 3.0% .50%-7 Yrs. .50%-12 Yrs. .50%-30 Yrs.
April 17, 1994—30 year
FY 1993 until 2.0% None .25%-4 Yrs. .25%-8 Yrs.
April 17, 1994—15 year
April 17, 1994 and 2.25% .50%-7 Yrs. .50%-12 Yrs. .50%-30 Yrs.
Beyond—30 year
April 17, 1994 and 2.0% None .25%-4 Yrs. .25%-8 Yrs.
Beyond—15 year
January 1, 2001 and 1.50% .50% .50% .50%
beyond—30 year
January 1, 2001 and 1.50% None .25% .25%
beyond—15 year
NOTES:
* Monthly MIP is eliminated when loan balance is 78% of original purchase price effective with loans closed after
1/01/01 provided premium has been paid for at least five years.
* 1.75% up-front for first time homebuyers receiving housing counseling 9/22/97 to 12/31/00.
* 2.00% up-front for first time homebuyers receiving housing counseling as of 9/3/96 to 9/21/97.
* Up front MIP is not applicable to condominiums. Condominiums are .50% monthly for 30 years.
* Federal Fiscal Year runs from October 1 to September 30. October 1992 started Fiscal Year 1993.
* FHA Streamline Refinances of single family homes originated before July 1, 1991 are exempt from Monthly MIP effective
April, 1992. (New up-front premium is 1.5%)
*3.8% with no monthly MIP ended July 1, 1991.
* Lower upfront MIP for 15 year mortgages effective December 26, 1992.
Table 2-3
4. Lender paid prepaids. The borrower may opt for a higher interest rate from the lender which
will enable the lender to give a credit towards the borrower's prepaid charges. This does not
affect the required FHA down payment in any way, unless the discount points to the seller are
increased to accommodate this credit.
For example:
-Lender Interest Rate Quote: 8.00% with one point
-Prepaid Credit Quote: 8.50% with one point credit
-If Mortgage is $100,000: Credit $1,000 towards prepaid charges
5. FHA prepayments. During the payoff of an FHA mortgage, the lender has the right to collect
interest to the end of the month in which the payoff occurs. This differs from conventional
mortgages in which interest collection stops the day the lender receives the payoff amount.
This is important to note because a homeowner selling or refinancing a home which has an
FHA mortgage should schedule the closing towards the end of the month, but not the last day
because this may not leave enough time for the closing agent to get the payoff to the present
lender. If the payoff is received by the lender one day late (the first of the next month), the
18
lender will be entitled to charge an extra month's interest. In the earlier years of the FHA
program, the FHA note required the seller to give a notice of 30 days before payoff, which
further exacerbated the payoff situation. It is important to read the terms of your FHA note
before embarking upon a sales or refinance transaction.
FHA qualification requirements

The qualification requirements for FHA mortgages are less stringent than comparable conventional
mortgages. The following differences highlight the extent of this leniency:
• Qualification ratios. While standard
conventional qualification ratios are 28/
36, FHA allows a housing ratio of 29% FHA Monthly MIP Factors
and a debt ratio of 41%. On January 27, Monthly MIP Payment per $1,000 of Loan Amount
1995, FHA published Mortgage Letter 30 Year 15 Year
95-7 which stated its intention for these Interest
ratios to be guidelines only. In addition, Rate 0.50% 0.25%
FHA publishes specific compensating 4.0% 0.4133 0.2036
factors by which these ratios may be 4.5% 0.4136 0.2038
5.0% 0.4139 0.2040
exceeded:
5.5% 0.4141 0.2042
1. A conservative attitude towards the 6.0% 0.4143 0.2043
use of credit and demonstrated ability 6.5% 0.4146 0.2045
to accumulate reserves, resulting in 7.0% 0.4148 0.2046
7.5% 0.4149 0.2048
a minimum of three months
8.0% 0.4151 0.2049
mortgage reserves after closing. 8.5% 0.4152 0.2051
2. A minimum of 10% cash investment 9.0% 0.4154 0.2052
in the property. 9.5% 0.4155 0.2054
10.0% 0.4156 0.2055
3. A small (not more than 10%) 10.5% 0.4157 0.2056
increase in housing expense. 11.0% 0.4158 0.2057
4. The borrower receives compensation 11.5% 0.4159 0.2059
12.0% 0.4160 0.2060
not reflected in the effective income, 12.5% 0.4161 0.2061
but directly affecting the ability to To calculate monthly MIP, multiply the loan amount, in thousands, by
pay the mortgage and other the factor from the table. For example, a $100,000, 30 year loan at 7.5%
would be 100 x 0.4149 = $41.49 monthly MIP.
obligations.
5. A considerable amount of effective Table 2-4
income comes from non-taxable
sources.
6. Income of a temporary nature, while not considered effective, may be considered available to
meet short term non-recurring charges.
7. The term of the mortgage is less (by five years or more) than the maximum available.
8. Smaller families whose living needs permit them to live on less than larger families.
19
Chapter 2
9. The ratios may be exceeded by two percent when the dwelling has been identified as energy
efficient.
10. A down payment of 25% or more decreases the importance of ratio calculations.
• Cash requirements are less. The cash requirements for an FHA transaction are less than for a comparable
conventional transaction:
1. FHA requires less than the typical 5.0% down payment required on conventional mortgages
(Conventional mortgages requiring less than 5% down typically require high credit scores or a
higher interest rate. FHA does not require minimum credit scores).
2. FHA does not require two months cash reserves. Three months reserves are required on 2-4 unit
properties. 9
3. All cash may come from a gift from an immediate family member, or someone with a family-
type relationship. Most conventional mortgages require 5.0% of the cash to be from the purchaser's
own funds. Gifts from a bridal registry or other legitimate occasion where substantial gifts are
typically received are allowed, if deposited in a supervised account.
4. The funds for down payment and closing costs can be borrowed, but the loan must be secured and
the borrower must qualify for the additional monthly payments. Funds for the downpayment can
be borrowed unsecured from an immediate family member or be provided by a grant program.
5. All mortgage insurance can be financed in the mortgage amount rather than paid in cash.
• FHA co-borrower rules. FHA allows co-borrowers to help qualify for the mortgage and these co-
borrowers do not have to live in the property (one unit properties only) 10. The co-borrower must be
an immediate family member or have a family-type relationship, and cannot contribute the vast majority
of resources (cash and income) to the transaction. In other words, it must make sense that the occupant
can make the payments and that the co-borrower is not an investor. The property must be 1 unit if the
LTV is over 75% and a non-owner occupant co-borrower is being used.
• Non-citizens. Borrowers do not have to have a green card11 to receive an FHA mortgage.
• Second trusts. FHA is more stringent than most mortgage programs with respect to the placing of the
second mortgage behind an FHA mortgage during a purchase transaction. FHA does allow the placing
of a second trust but:
1. The combination of the first and second trust cannot lower the required down payment or raise the
maximum mortgage amount. Therefore, the second trust will save the purchaser no cash at
settlement.
2. Regardless of the loan-to-value due to the existence of the second, the purchaser must still pay
FHA mortgage insurance.
3. The combined mortgage amount of the first and second trust cannot exceed FHA maximum
mortgage limits set in the local jurisdiction.
In other words, there is no advantage in placing a second mortgage behind an FHA first mortgage
during a purchase transaction. There are no restrictions regarding placing a second mortgage
behind an FHA mortgage when the FHA mortgage is being assumed by the purchaser of the
property. This practice is quite common because it lessens the cash required for purchase assumption
transactions.
9
15 Days prepaid interest must be made a part of the required cash for qualification purposes. In other words, the lender must assume
that the closing will take place in the middle part of the month.
10
They are therefore referred to as non-owner occupant coborrowers.
11
A green card is a document which makes a non-citizen residing in the United States a resident alien, or one who can reside in the
United States.
20
The Department of Veterans Affairs (VA)

The VA program was established in 1944 to provide for the veteran by guarantying against foreclo-
sure a portion of mortgage loans procured through the program. The word guaranty is very important in
this regard. Unlike FHA mortgages, which are insured against default in a program paid for by the users
of the program:
• The VA program is not an insurance program, but a benefit program for veterans. Throughout its
history, VA losses are not offset by insurance premiums. In was only later in the program history that
VA began collecting a Funding Fee in order to offset administrative expenses.
• The VA program guaranties only a portion of the mortgage against default while an FHA mortgage is
100% insured against default. If the loss in a foreclosure process exceeds the amount of VA mortgage
guaranty, the lender is at risk. Basically, when a VA mortgage goes into default, VA has the option of
taking over the problem by auctioning the house and paying off the lender, or remitting to the lender
the amount of guaranty in cash and letting the lender dispose of the property. The latter situation is
called a VA no-bid. Congress sets the formula by which VA determines which defaults results in no-
bids. Basically, VA lending has become more risky than FHA lending because the lender is giving
recourse, or is at risk for future losses beyond those which are covered with the VA guaranty. Because
of this extra risk, it is not unusual for lenders to charge higher points for VA mortgages as compared
to FHA. Other lenders have added qualification standards which exceed VA minimums.
• The VA home loan program benefits a specific population group which is comprised of veterans,
active military and the members of the armed forces reserves. FHA is geared to benefit the population
as a whole. Like FHA, VA does not provide funds for the mortgage—it just facilitates lending by
providing assurance against default.
Who is eligible to obtain VA mortgages?

Any Veteran who served on continuous active duty for the number of days required during the time
frames listed below and has received an honorable release or discharge is eligible for the program:
World War II 9/16/40 to 7/25/47 90 Days
Pre-Korean 7/26/47 to 6/26/50 181 Days
Korean Conflict 6/27/50 to 1/31/55 90 Days
Post Korean 2/01/55 to 8/04/64 181 Days
Vietnam Conflict 8/05/64 to 5/07/75 90 Days
Post Vietnam 5/08/75 to 9/07/80 181 Days (Enlisted)
5/08/75 to 10/16/81 181 Days (Officers)
Enter After 9/07/80 24 Months (Enlisted)
10/16/81 24 Months (Officers)
Persian Gulf 8/2/90 to 2 Years or Period called to active
duty (not less than 90 days)
Note: If applicants are active military personnel, they need to have served 181 days to be eligible. If
they are separated from service, they need to have had 24 months continuous duty to be eligible.
In addition the following are also eligible:
• Commissioned Public Health Officers, National Oceanic and Atmospheric Administration Officers,
Environmental Science Service Administration Officers, and Coast and Geodetic Survey Officers.
21
Chapter 2
• A veteran discharged because of service related disability without minimum qualifying time may still
be eligible.
• A surviving spouse (not remarried) of a veteran who died, either in service or after separation, as a
result of a service connected injury or disease.
• Under the Veterans Home Loan Program Amendments of 1992, individuals who have completed a
total of at least six years in the Reserves or National Guard.12
There is no limit to the number of VA mortgages a veteran can obtain as long as there is remaining
guaranty or eligibility for each mortgage. Funding fee schedules indicate a higher cost for second time
usage. There are some exceptions to the 24 month rule for reductions in force and other discharges for the
convenience of the government.
Types of transactions financed under VA

Owner occupied purchase transactions. The vast majority of VA mortgages are owner occupied pur-
chase transactions. The purpose of the program is to assist the veteran in obtaining housing.
Owner occupied refinance transactions. Veterans can refinance their present mortgages for the pur-
pose of lowering the interest rate or taking equity out of the property. The maximum loan-to-value on
these transactions is 90%. The veteran must have guaranty or entitlement which was not previously
utilized in the procurement of a VA mortgage. In addition, if the property has no present mortgage, or is
free and clear, VA will not permit a VA mortgage to be placed upon the property (in this case the veteran
would be attempting a cash out refinance upon a property with no present mortgage).
Interest rate reduction refinances. A veteran can refinance his/her present VA mortgage in order to
reduce the interest rate13 under the VA Fasttrack Program. The veteran need not still live in the home in
order to effect an interest rate reduction refinance, and a new guaranty is not necessary. VA does not
require the verification of income or a new appraisal on these mortgages (though lenders may require a
new appraisal). All closing costs can be rolled into the new loan amount under this refinance program. VA
proposed a rule in early 1996 directing that lenders charge no more than 2 discount points on VA refi-
nances. If the loan exceeds 2 points, a statement must be signed by the borrower.
Assumptions. VA mortgages are freely assumable at the same rate and terms, with a credit check
required for mortgages closed after March 1, 1988. For processing assumptions, the lender can charge
$300, and .5% is charged by VA for a funding fee. The fee is $45 for loans closed before March 1, 1988.
Owner occupants or investors can assume VA mortgages.
12
This eligibility was extended through September 30, 2007. Those eligible under this provision are subject to a higher funding fee.13
VA requires that the new payment be lower. The veteran can move to a 15 year mortgage which increases payments under this
refinance program. A veteran may refinance out of an ARM even if the new payment is higher. The lender must certify that the veteran
is able to make the new payment in cases where the PITI is increased by 20% or more.
13
VA requires that the new payment be lower. The veteran can move to a 15 year mortgage which increases payments under this
refinance program. A veteran may refinance out of an ARM even if the new payment is higher the lender must certify that the veteran
is able to make the new payment. In cases where the PITI is increased by 20% or more.
22
Types of properties eligible for VA

The types of properties eligible for VA financing mirror FHA programs for the most part:
• 1-4 unit single family properties. Unlike FHA, the maximum mortgage amount is not increased for
multiple unit properties.
• Properties which are located in planned unit developments (PUDs).
• Properties which are located in condominium developments.
Condominium developments have to be approved by VA and the guidelines are similar to those
employed by FHA. The most pronounced exception is the fact that VA does not have a 51% owner-
occupancy requirement for condominium projects and VA does not require environmental assessments
for condominiums. In September of 2000, the VA lender handbook was updated to eliminate the require-
ment that planned unit developments needed VA approval.
VA appraisals are called Certificates of Reasonable Value, or CRVs, and appraisals of new projects
are called Master Certificates of Reasonable Value, or MCRVs. These appraisals are valid for a six month
period upon issuance. New homes must have plans and specifications approved directly by VA, however
a small number of homes can be allowed on a spot basis with an approved homeowners warranty pro-
gram. In these cases the appraisal would be ordered at what is called the customer preference stage. At this
stage the home is completely finished, except for items the purchaser chooses: carpet, tile, appliances, etc.
After these items are installed, a final inspection is ordered and performed by VA. Exceptions to the
warranty rule can be made on a spot basis if the builder is not more than occasionally involved with VA
financing and certain acknowledgements are made by the veteran.
Unlike FHA, VA does not allow staff appraisers employed by the lender. Under a pilot program called
LAPP (Lender Appraisal Processing Program), the appraiser sends the appraisal directly to the lender to
process. Under normal VA procedures, all appraisals are sent to the Property Valuation Section of VA and
VA issues the appraisal, or CRV. The lender can issue the approval after receiving the appraisal if the
lender is a VA Automatic lender.
Mortgage types offered under VA

Fixed rates. By far the most prevalent VA mortgages are 15 and 30 year fixed rates. VA does not have
a major track record of encouraging any other type of mortgage programs. Like FHA, the rates are avail-
able in one-half of one percent increments. Until November of 1992, VA set an interest rate ceiling which
could be charged to the veteran for all VA mortgages except for refinances. The veteran was also not
allowed to pay any discount points charged in connection with the mortgage. Under the Veterans Home
Loan Program Amendments of 1992, this interest rate ceiling was lifted and veterans were permitted to
pay discount points directly.14
Temporary buydowns. Temporary buydowns of VA fixed rate mortgages have not been popular in
the past few years. The reasons for this are:
• Qualification. VA does not allow qualification at the bought down rate unless it can be proven that the
income will increase in the future. Cost of living increases are specifically excluded and the increase
must be proven. VA will allow the lower payment to offset a debt payment which will be paid off in
the near future.
14
Under the rules implementing this legislation, veterans were not allowed to roll in the cost of discount points in VA refinance
transactions. This rule has since been rescinded.
23
Chapter 2
• The VA maximum interest rate. Until November of 1992, VA had a published maximum interest rate
which could be charged to the veteran. The veteran was also precluded from paying any discount
points charged on the mortgage. Since buydowns significantly increase the points associated with the
mortgage, it is normal to buy-up the permanent interest rate in order to minimize the increase in
points. It was not possible to buy-up the rate of VA mortgages because of the interest rate ceiling set
by VA. With the elimination of the maximum VA rate, now mortgage rates can be "bought up" to
allow for a temporary buydown with lower discount points.
• Point premium. Like FHA buydowns, VA buydowns must be placed in a GNMA II pool which can
result in a premium of as much as one point in addition to the actual cost of the buydown.
VA GPMs. VA offers a graduated payment mortgage which is identical to the FHA Plan III previously
described. The fact that the mortgage carries scheduled negative amortization and a higher down payment
has limited the popularity of this program. The interest rate is also identical to the FHA GPM program —
.25% above FHA/VA 30 year fixed rates
VA ARMs. Under the Veterans Home Loan Program Amendments of 1992, Congress authorized a
test program to offer one year adjustable rate mortgages which are identical to those offered under the
FHA mortgage program (1% adjustment cap and 5% life cap with a “T” Bill index). The veteran is
qualified at 1% over the initial interest rate. The authority expired in 1995 and was not renewed by
Congress.
Energy efficient mortgages. The 1992 Amendments also authorized the financing of improvements to
properties in order make the property energy efficient. From $3,000 to $6,000 (depending upon the
degree of utility savings) can be added to the mortgage for these improvements for purchase and refi-
nance transactions. This provision can be utilized even if the veteran is financing the maximum amount
for which he/she is eligible.
Maximum VA mortgage amount

VA does not actually set a mortgage limit—they limit the amount of guaranty which can be extended
for each mortgage (currently $50,750). This guaranty cap will actually limit the size of VA mortgages by
requiring the veteran to increase his/her down payment when this limit is exceeded. More importantly,
Ginnie Mae will not purchase a VA mortgage above $203,000. The Ginnie Mae mortgage cap provides
the real limit for VA mortgages because lenders cannot sell VA mortgages over $203,000 in the second-
ary market, even though VA has the ability to guaranty mortgages above the $203,000 limit. In the past
few years, Fannie Mae has begun purchasing VA jumbo mortgages up to the conforming loan amount.
However, a veteran with full eligibility must make a downpayment of 25% of the amount over $203,000.
Costs to obtain a VA mortgage
Down payment. It is within the discussion of down payment that we must advance and define the
concept of the words guaranty, eligibility, and entitlement which keep turning up within our exploration
of VA mortgages. Basically, each veteran is eligible or entitled to have a certain portion of a VA mortgage
guarantied against default. Usually, 25% of the mortgage amount is guarantied by VA. This guaranty
serves as a substitute for cash equity in the eyes of the lender because the lender knows that VA will send
the equivalent in cash if the mortgage defaults. Therefore, the amount of guaranty actually will allow a
maximum VA mortgage without a down payment by the Veteran.
24
Example:
If the Veteran has eligibility for a $50,750 guaranty, the maximum VA mortgage without a down
payment would be:
$50,750 x 4 = $203,000 (It is no coincidence that the GNMA mortgage purchase limit of $203,000
coincides with four times the current maximum VA guaranty of $50,750. This means that VA will
guaranty 25% of $203,000, or $50,750)
How do we determine how much entitlement a veteran currently has? Basically, if the veteran never
has used his/her VA eligibility in the past, the veteran would have a maximum entitlement of $46,000. If
the veteran had a VA mortgage in the past and did not regain the used entitlement15, the veteran would
have lost a certain amount of guaranty. Congress has periodically increased the guaranty throughout the
history of the VA mortgage program. The amount of increase would give the veteran who has already
used all or most of his/her entitlement what is called a partial entitlement.
For example:
- If a veteran purchased a home in 1979 for $100,000, the veteran would have used $25,000 in
entitlement
- In 1988 the entitlement was increased to $36,000, giving the veteran a partial entitlement of
$11,000.
- In 1989 the entitlement was increased to $46,000 and 1994 to $50,750, but only for the purpose
of purchasing a home with a sales price greater than $144,000. Therefore, the partial remains at
$11,000 for a sales price below $144,000.
The veteran can purchase a second home under the VA mortgage program without disposing of the
first home as long as the next purchase is also for an owner-occupied home (the first home would have to
be converted to a rental property), and as long as the new home has at least 25% in guaranty by VA or
cash down payment by the veteran. In the above example, the veteran has only a partial of $11,000 and
can only purchase four times that amount with no money down. Therefore, the veteran would have to
make a 25% down payment for any portion of the sales price above $44,000.
Example: Sales Price: $80,000
$36,000 x 25%: 9,000
Entitlement: 11,000
Down Payment: 9,000
$11,000 x 4: 44,000
VA Mortgage: 71,000
$80,000 - $44,000: 36,000
The formula for figuring the maximum mortgage amount with partial entitlement would be:
Sales Price x 75% + Eligibility = Maximum Mortgage Amount
$80,000 x 75% = $60,000 + $11,000 = $71,000
15
A veteran regains used entitlement in one of two ways. The most common method is reinstatement, which means that the property is
sold and the mortgage is paid off (both events must occur). In October 1994 Public Law 103-446 was passed which allowed a one time
only restoration for a veteran whose loan has been paid in full but had not disposed of the the property. The second method is substi-
tution of eligibility, which means that the home is sold and the VA mortgage is assumed by another veteran who substitutes his/her
eligibility of an equal amount during the process of assuming the mortgage. In either case, if the veteran is selling his/her home and
purchasing another, back-to-back settlements are not usually possible because the certificate of eligibility (COE) must be updated. In
a back-to-back settlement, the home seller leaves one settlement table to go to the next settlement as the purchaser of another home on
the same day.
25
Chapter 2
The amount of entitlement is designated on a VA form called a Certificate of Eligibility, or COE. This
form is obtained through each Regional VA Office and can be updated every time there is a change in
entitlement.
Funding fee. Though the VA mortgage program is not financed through user paid insurance, the
veteran must pay a funding fee, to reimburse VA for the cost of administering the program. Effective
October 1, 1993 veterans using their VA eligibility for a second time must pay a higher fee. The cost of
the funding fee stated as a percent of the mortgage amount is as follows:
2.00% - For purchase mortgages with less than a 5% down payment.
(2.75% Reservists) For all refinances except VA Interest Rate Reduction Refinance
(3.00% Multiple Users) Mortgages.
1.50% - For purchase mortgages with at least 5% down, but less than a 10%
(2.25% Reservists) down payment.
(1.50% Multiple Users)
1.25% - For purchase mortgages with at least a 10% down payment.
(2.00% Reservists)
(1.25% Multiple Users)
.50% - For Interest Rate Reduction Refinance Mortgages including Reservists.
VA allows the funding fee to be financed into the mortgage amount without affecting the amount of
eligibility.
Example:
Sales Price: $100,000
Mortgage Amount: $100,000
Amount of Funding Fee: 2.00%, or $2,000
Mortgage Including Funding Fee: $102,000
The only exception to the rule allowing financing of the VA funding fee is for mortgages at the Ginnie
Mae limit of $203,000. The VA funding fee may be financed unless it would cause the mortgage amount
to exceed this limit. On VA interest rate reduction refinances, the $203,000 limit can be exceeded in
order to roll in closing costs including the funding fee.
Veterans receiving VA disability are eligible to have their funding fee waived by VA. The lender
sends a VA Indebtedness Letter to VA to certify that the veteran does not have any outstanding obliga-
tions to the Department of Veterans Affairs. If evidence of VA disability is attached to this form, VA will
indicate the exemption from the VA funding fee.
Non-allowable VA closing costs. Like FHA, VA does not allow the veteran to pay miscellaneous fees
above and beyond the loan origination fee. Therefore, on purchase transactions the tax service, lender
inspection, and other fees will be paid by the seller of the property. These fees cannot be charged on
refinances.
The seller can pay all discount points, temporary buydown funds, closing costs, and prepaids associ-
ated with the transaction. With no down payment and the seller paying all closing costs, the veteran can
26
literally move in with no cash utilized in the transaction. There is a limit of 4% of the sales price that the
seller can contribute towards the borrower's costs in the transaction, however normal discount points and
closing costs do not count towards the 4% limitation.
VA qualification requirements
VA makes home buying more affordable and achievable for veterans in several ways:
• Residual method. VA is the only major mortgage source which continues to use the residual method
of qualification. The residual method figures qualification by subtracting all expected expenses from
a veteran's income. If the residual figure is positive, the veteran qualifies. If the residual figure is
negative, the veteran does not qualify. Generally, the residual method is an easier qualification standard
than the widely utilized ratio method. A more in-depth discussion of this concept can be found in
Chapter 4, Qualifying For A Mortgage.
• Higher ratios. VA also applies a second qualification standard: a debt ratio of 41%, which coincides
with FHA's second ratio. Generally, if the second ratio exceeds 41% the lender must have compensating
factors. This would include recalculation of the residual method to determine if the residual remains
positive after 20% is added to the family support category. With most conventional standards employing
a 36% debt ratio, the second standard of VA qualification remains more liberal than comparable
conventional mortgages.
• Cash requirements. The cash requirement for a VA mortgage is less than any other major mortgage
source:
- Zero down payment is required.
- The VA funding fee can always be financed, unless the mortgage amount exceeds $203,000.
- The seller can pay for all closing costs and prepaids.
- There is no requirement for cash reserves after closing.
- The veteran can receive gift funds for any and all cash requirements.
- The veteran can borrow on unsecured terms for any cash requirements, excepting to pay above
the appraised value of the property if the sales price exceeds the appraised value.
Not all qualification requirements for VA mortgages are less stringent than conventional mortgages.
There are some standards which are very strict:
• Co-borrower requirements. Since the VA mortgage program is a benefit program for veterans, it is
quite understandable that the participation of non-veterans is restricted. Non-owner occupant co-
borrowers are strictly forbidden in the VA mortgage program. There are basically only two classes of
owner occupant co-borrowers which are allowed:
1. The spouse of the veteran is an eligible co-borrower. In addition, if the spouse of the veteran is
also an eligible veteran, either entitlement can be utilized to acquire the VA mortgage.
2. Another eligible veteran. Two non-related veterans can purchase a home together if they both are
going to live in the house. In this case, a portion of the entitlement will be utilized by both
veterans. These mortgages must be approved directly by VA, even if the lender has VA Automatic
authority.
3. Non-veterans (not a spouse). Though VA may approve a loan purchased with a non-veteran,
these loans are not likely to be guaranteed in full and therefore not eligible to be purchased by
Ginnie Mae. Because the loan can't be sold, most lenders will not be able to make such a loan.
27
Chapter 2
• Secondary financing. A second trust behind a VA first trust is not allowed to decrease the cash down
payment required by the veteran (if there is one). For example, if the veteran has remaining eligibility
of $15,000 and the sales price is $100,000:
$100,000 x 75% = $75,000 + $15,000 = $90,000 maximum mortgage
$100,000 - $90,000 = $10,000 minimum down payment
The VA mortgage is $90,000. The $10,000 must be in cash. A second trust is not allowed to “lower”
the down payment:
The following configuration is not allowable
$90,000 First Mortgage
5,000 Second Mortgage “ 9 0 - 5 - 5 ”
5,000 Down Payment
• VA jumbos. There is one situation in which a second trust would be advantageous when paired with
a VA first mortgage. That is when the sales price dictates a VA mortgage amount over $203,000,
which is not possible because of the Ginnie Mae purchase limitations:
Example: Sales Price: $220,000
Full Eligibility: $50,750
$220,000 x 75% = $165,000 + $50,750 = $215,750 maximum mortgage
$220,000 -$215,750 = $4,250 minimum down payment
Because GNMA limits mortgage purchases to $203,000, the real down payment requirement:
$220,000 - $203,000 = $17,000 minimum down payment
The following configuration is allowable:
$203,000 VA first mortgage
$ 12,750 second mortgage
$ 4,250 down payment History of VA Entitlement
It should be noted, that the combined loan-to- $4,000 ......................................... World War II
value, or CLTV of the first and second mortgage is $7,500 ......................................... Increase 7/12/50
98%. It is not likely that the veteran will find a com- $12,500 ....................................... Increase 5/7/68
$25,000 ....................................... Increase 10/2/78
mercial second mortgage lender to offer such a mort- $27,500 ....................................... Increase 10/1/80
gage. Therefore, the second mortgage will have to $36,000 ....................................... Increase 2/1/88
be taken back or held by a private party—usually $46,000 ....................................... Increase 12/18/89*
$50,750 ....................................... Increase 10/13/94*
the seller. VA will currently guaranty:
This same formula would apply for the Fannie • 50% of mortgages up to $45,000
• $22,500 maximum for mortgages over $45,000 and
Mae VA jumbo purchase program. For a sales price up to $56,250
of $220,000 and full eligibility of $50,750, the maxi- • The lesser of $36,000 or 40% of the mortgage for
mum loan amount would be $215,750 with a $4,250 mortgages of $56,250 up to $144,000
• The lesser of $50,750 or 25% of the mortgage for
downpayment. mortgages over $144,000*
*The increase to $46,000 is for purchases over
$144,000 only
*The increase to $50,750 is for purchases over
$144,000 only
Table 2-5
28
30 YEAR MORTGAGE RATE CHANGES—A FIFTY YEAR HISTORY

Effective Date Percent Effective Date Percent Effective Date Percent
April 24, 1950 4% March 9, 1981 14% December 19, 1988 10 1/2%
April 2, 1953 4 1/2% April 13, 1981 14 1/2% June 2, 1989 10%
December 3, 1956 5% May 8, 1981 15 1/2% July 17, 1989 9 1/2%
August 5, 1957 5 1/4% August 17, 1981 16 1/2% February 23, 1990 10%
September 23, 1959 5 3/4% September 14, 1981 17 1/2% November 19, 1990 9 1/2%
February 2, 1961 5 1/2% October 12, 1981 16 1/2% February 5, 1991 9%
May 29, 1961 5 1/4% November 16, 1981 15 1/2% June 17, 1991 9 1/2%
February 7, 1966 5 1/2% January 25, 1982 16 1/2% August 12, 1991 9%
April 11, 1966 5 3/4% March 2, 1982 15 1/2% September 18, 1991 8 1/2%
October 3, 1966 6% August 9, 1982 15% December 20, 1991 8%
May 7, 1968 6 3/4% August 24, 1982 14% February 24, 1992 8 1/2%
January 24, 1969 7 1/2% September 24, 1982 13 1/2% July 6, 1992 8%
January 5, 1970 8 1/2% October 12, 1982 12 1/2% August 12, 1992 7 1/2%
December 2, 1970 8% November 15, 1982 12% October 28, 1992 VA Rate
January 13, 1971 7 1/2% July 11, 1983 12 1/2% Deregulated
January 18, 1971 7% May 9, 1983 11 1/2% *November 1992 8.31%
August 10, 1973 7 3/4% June 8, 1983 12% January 1993 7.99%
August 25, 1973 8 1/2% August 1, 1983 13 1/2% July 1993 7.21%
January 22, 1974 8 1/4% August 23, 1983 13% January 1994 7.07%
April 15, 1974 8 1/2% November 1, 1983 12 1/2% July 1994 8.61%
May 13, 1974 8 3/4% November 30, 1983 FHA Rate January 1995 9.15%
July 5, 1974 9% Deregulated July 1995 7.61%
August 14, 1974 9 1/2% March 21, 1984 13% January 1996 7.03%
November 24, 1974 9% May 8, 1984 13 1/2% July 1996 8.25%
January 21, 1975 8 1/2% June 8, 1984 14% January 1997 7.82%
March 3, 1975 8% August 13, 1984 13 1/2% July 1997 7.50%
April 28, 1975 8 1/2% October 22, 1984 13% January 1998 6.99%
September 3, 1975 9% November 21, 1984 12 1/2% July 1998 6.95%
January 3, 1976 8 3/4% March 25, 1985 13% January 1999 6.79%
March 30, 1976 8 1/2% April 19, 1985 12 1/2% July 1999 7.63%
October 18, 1976 8% May 21, 1985 12% January 2000 8.21%
May 31, 1977 8 1/2% June 5, 1985 11 1/2% July 2000 8.15%
February 28, 1978 8 3/4% November 20, 1985 11% January 2001 7.03%
May 23, 1978 9% December 13, 1985 10 1/2%
June 29, 1978 9 1/2% March 3, 1986 9 1/2%
April 23,1979 10% November 24, 1986 9%
September 26, 1979 10 1/2% January 19, 1987 8 1/2%
October 26, 1979 11 1/2% April 10, 1987 9 1/2%
February 11, 1980 12% May 5, 1987 10%
February 28, 1980 13% September 4, 1987 10 1/2%
April 4, 1980 14% October 5, 1987 11%
April 28, 1980 13% November 10, 1987 10 1/2%
May 15, 1980 11 1/2% February 1, 1988 9 1/2%
August 20, 1980 12% April 3, 1988 10%
September 22, 1980 13% May 20, 1988 10 1/2%
November 24, 1980 13 1/2% November 1, 1988 10%
Note: Following the VA maximum interest rate over the years provides a good insight to the movement of interest rates
during the "modern era" of mortgage lending. *After deregulation of the maximum VA interest rate, the number provided
from November 1992 forward is the FHLMC Primary Mortgage Market Survey for 30-year fixed mortgages (does not
include average points charged).
Table 2-6
29
Chapter 2
State and local bond issues

Financing for homes is provided by State and local governments through the Federal Bond Subsidy
Act. This legislation authorizes these governments to issue tax free bonds to the public. The purchasers of
these bonds receive income at a specified interest rate, but the interest income earned is not taxable by
state and federal governments. Because of the bonds' tax free status, the interest rates paid by the govern-
ments can be less than what is paid by banks and other interest rate denominated investments. These
lower interest rate bonds finance mortgages which also carry below market interest rates.
These below market rate mortgages are available to first time home buyers16 whose income
is not more than 100% of the median income for the area (moderate income), or 80% of the in-
come for the area (low income). The local agency may offer lower interest rates to low income individu-
als.
The sales prices for the homes are limited to 90% of the average area purchase price17 applicable for
such homes. Typically, there may exist separate maximum sales prices for new homes and existing
homes. There also is usually a limitation as to the allowable cash assets of the participants in the programs.
There are targeted areas which are qualified census tracts, or areas of chronic economic distress in
which 70% or more of the families have income which is 80% or less of the statewide median family
level. In these areas the interest rate may be lower, or there may be leniency in one or more of the
qualification rules or eligibility standards necessary to procure the mortgages. These include exceptions
to the first time home buyer requirement, and increased sales prices up to 110% of the average purchase
price of the area. At least 20% of a particular bond issue must be available for lending within targeted
areas.
Who is eligible for bond issues?

The eligibility standards may vary from program to program, but minimum standards include the
principal residence of buyers who have not had an ownership interest in real property for the previous
three years. The income of these buyers cannot exceed 100% of the median area income and there are
maximum cash asset requirements. In this section we have a chart of the medium income limits for major
areas within the United States.
Types of transactions financed

Generally, lending is limited to owner occupied purchase transactions. Refinances are prohibited.
However, there are provisions for the agencies to issue loans for the rehabilitation of properties and home
improvement loans.
Types of properties eligible

Generally, any types of properties which can be financed through FHA and VA can be financed
through these programs, including condominium projects and planned unit developments. The home
cannot be utilized for the generation of income. While the agencies may enforce this restriction differ-
ently, the regulations state that if over 15% of the home is utilized for business, the home would not
qualify for financing. Two to four unit properties are not excluded, yet the maximum sales price is not
increased for these properties. It is expected that the square footage which would be dedicated to rental
16
By definition, a first time home buyer is one who has not had an interest in real property for the previous three years.
17
The term acquisition cost is utilized in the legislation to ensure that the maximum sales price is not exceeded by the purchase of an
unfinished property. The acquisition cost is defined as the purchase price and the estimated cost to finish the property. This acquisition cost
cannot exceed the maximum sales price.
30
income would provide a problem concerning the aforementioned restriction regarding business use of the
home.
Mortgage types offered

It would be unusual for anything other than a fixed rate mortgage and a temporary buydown of that
fixed rate mortgage to be offered. Each bond issue would typically carry one or few rate and point
options.
Some programs will offer second mortgages which can lessen the cash requirements of a first mort-
gage program. The first mortgage might also be offered under a Bond Program, or the first mortgage may
be an FHA, VA, or Conventional mortgage. Both Fannie Mae, Freddie Mac, and FHA have special provi-
sions under their Community Homebuyer and Affordable Gold mortgage programs which allow the bor-
rower to procure some portion of the necessary cash from a local or state jurisdiction—either as a loan or
a secured second mortgage.
Many of the mortgages offered under this program can be insured by FHA or guaranteed by VA. In
effect, FHA or VA mortgages are offered, but a government agency is lowering the interest rate and
providing the funds. In these cases, the borrower must meet the eligibility guidelines of the Federal Bond
Subsidy Act, the local governmental entity, and the qualification guidelines of FHA or VA.
Maximum mortgage amounts

The maximum mortgage amount will be governed by the sales price limitations in each jurisdiction. If
the maximum sales price is $100,000 and the program requires a five percent down payment, then the
maximum mortgage amount in this case will be $95,000, plus any mortgage insurance or funding fee
which can be financed.
Costs to obtain a bond issue mortgage

The costs to obtain mortgages originated under the Federal Bond Subsidy Act will vary from program
to program but the most common variations are as follows:
• Down payments. Required down payments will vary from five percent for those programs which are
insured by conventional private mortgage insurance to zero down payment for VA guaranteed mortgages
and local entities which offer government sponsored mortgage insurance or second trusts. If the
mortgages are insured by FHA, the down payment will be approximately 2.25%.
• Mortgage insurance. If FHA or VA is the insuring or guaranteeing agency, then the costs will mirror
those programs. The cost of programs with local and state government sponsored mortgage insurance
will vary from jurisdiction to jurisdiction. If private mortgage insurance is offered, the costs will
mirror those costs for a conventional mortgage with a five percent down payment, unless a higher
standard of coverage is required.
• Recapture tax. While the home buyer will receive a significant advantage through a below market
interest rate, the participation in these mortgage programs may carry costs further down the road. For
loans closed after December 31, 1990, if the resale of the property occurs within 10 years of the
original purchase date, the home owner may be subject to a recapture tax of up to 6.25% of the
original loan amount. The amount of recapture tax will vary in accordance with various income
levels, the amount of gain on the sale and the length of time between purchase and sale.
31
Chapter 2
Bond issue qualification guidelines

These mortgages are generally more restrictive because of the eligibility requirements which include
maximum income and liquid asset guidelines. Once the eligibility requirements are met, the qualification
guidelines will be more lenient than conventional mortgages. These more lenient guidelines are typically
in the form of higher acceptable ratios. If VA or FHA mortgage options are offered, the qualification
guidelines of VA or FHA must be followed in addition to the bond requirements. Most jurisdictions do not
allow non-owner occupant co-borrowers or non-citizens without green cards (non-resident aliens).
Rural Housing Service (administered by the Farmers Home Administration)

The Federal Government also guarantees mortgages for rural properties under a program adminis-
tered by the rural development mission area of the U.S. Department of Agriculture. This program is called
the Guaranteed Rural Housing (GRH) loan program. These mortgages can be purchased by Fannie Mae,
Freddie Mac and GNMA. The GRH program is limited to rural areas which are defined as a maximum of
10,000 population for areas within metropolitan statistical areas and 25,000 within other areas. The
program finances only residential properties, and does not provide mortgages for farms. The borrowers
must have an income at or below 115% of the median income for the area. GRH maximum loan amounts
mirror FHA maximums and qualification guidelines.
There is a 1.00% guarantee fee levied upon 90% of the mortgage amount and there is no required
down payment. The government will guarantee up to 35% of the original principal and 85% of any loss
which exceeds that amount. The market share of these mortgages is growing. $3 billion nationwide was
authorized by Congress for fiscal year 1998. The mortgages are 30 year fixed with no seller contribution
limit. Applicants must be U.S. citizens or permanent resident aliens.
Conventional Conforming Mortgages

Conventional conforming mortgages are those which are eligible for purchase through the Federal
National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie
Mac) through authority granted by Congress. These agencies are chartered with governmental authority
but are private enterprises, and are known as government sponsored enterprises (GSEs) or quasi-govern-
mental institutions. In 1992, Congress gave the Department of Housing and Urban Development the
authority to regulate and oversee these institutions, obviously wary of a future savings and loan-type
bailout, and also concerned with progress these institutions have made in achieving public interests such
as providing financing for inner city housing and for minorities.
Who is eligible for conforming mortgages?

There is no limitation upon eligibility. Fannie Mae and Freddie Mac restrict non-resident aliens to a
minimum 10% down payment. Freddie Mac limits loans to non-resident aliens to primary residence only
and to those who have lawfully resided and been employed in the US for two years and have a two year
credit history.
32
Types of transactions financed

Many lenders negotiate specific commitments with Fannie Mae and Freddie Mac, and therefore the
rules of conforming lending may vary slightly from lender to lender. Here we will attempt to outline the
typical transactions financed:
• Owner occupied purchase and rate reduction refinance transactions. Conforming programs normally
will offer an owner occupied purchase with a minimum five percent down payment. To refinance, the
new mortgage must be no greater than 90% of the appraised value (there exists exceptions for
refinancing present conforming mortgages at 95% of the appraised value).
• Second home purchase and rate reduction refinance transactions. A larger down payment is required
for second home purchases, usually 20%. Refinances also require the new mortgage to be no larger
than 80% of the appraised value. In addition, the person applying for a mortgage on a second home
must have no more than three additional residential properties which are mortgaged.
• Investor purchase and rate reduction refinance transactions. Investor transactions typically require
30% equity in the property and carry higher interest rates as compared to owner occupied transactions.
The mortgage must be a fixed rate with no temporary buydown, and seller contributions are limited to
two percent of the sales price. The limitation of three additional financed properties applies to investor
as well as second home mortgages.
• Cash-out refinances. Fannie Mae and Freddie Mac normally do not allow cash-out refinances on
investor properties and second homes. The amount of cash out is usually limited to 75% of the value
of the home for owner occupied refinances. Some mortgage instruments, such as balloon programs,
may have more stringent cash out refinance requirements.
• Streamline refinance transactions. If the purchaser approaches the present servicer to refinance an
existing Fannie Mae and Freddie Mac mortgage solely to reduce the rate, streamline refinance programs
are offered which limit documentation, qualification, and valuation. For example:
- If the lender will warrant that the property value has not diminished, a new appraisal may not be
necessary;
- Re-qualification may not be necessary if the payment of the new mortgage is no more than 15%
higher than the qualification rate of the old mortgage, the income has not diminished, and the
original mortgage process verified the income.
• Rehabilitation and reverse mortgages. Fannie Mae has programs to finance construction and home
improvements (including FHA 203K mortgages) under their HomeStyle program and reverse mortgages
(HECM) under their Home Keeper program.
Types of properties eligible
Generally, residential properties of one to four units are eligible. Properties of 2-4 units usually require
higher down payments. Planned unit developments and condominium projects have special requirements
which can be quite complex. The following are examples of condominium classifications and require-
ments:
• Fannie Mae Limited Project Review
- 75% maximum loan-to-value with no secondary financing
- Project is complete and allows no short term rentals or multi-family ownership
- Owner occupied principal residence being financed
- Must have minimum insurance standards
33
Chapter 2
HUD Estimated Median Family Income Limits

Fiscal Year 2000 for MSAs
Note: Median income limits are utilized for a variety of purposes including several HUD
housing/rental subsidy programs and also to determine benchmarks for Fannie Mae and
Freddie Mac affordable lending program limits which may range from 100% to 170% of median
family income limits. Example: $31,700 x 115% = $36,455.
Nor theast
Northeast
Connecticut New Hampshire
Bridgeport $67,700 Lawrence $60,800 Utica-Rome 40,100
Danbury 87,400 Lowell 64,900 Westchester 83,100
Hartford 61,300 Manchester 56,500
New Haven 60,600 Nashua 64,100 Pennsylvania
New London 54,500 Portsmouth 52,300 Allentown $51,000
Norwalk 89,300 Altoona 38,300
Stamford 102,400 New Jersey Erie 41,700
Waterbury 58,000 Atlantic City 49,500 Harrisburg 50,300
Bergen-Passaic 72,600 Johnstown 32,400
Delaware Jersey City 53,200 Lancaster 49,500
Dover $46,800 Middlesex 80,800 Philadelphia 57,800
Wilmington 69,000 Monmouth 63,100 Pittsburgh 44,600
Newark 70,600 Reading 50,200
Maine Trenton 68,900 Scranton/Wilkes 42,200
Bangor $40,800 Vineland 47,200 Sharon 37,600
Lewiston 40,000 State College 44,200
Portland 49,000 New York Willliamsport 38,400
Portsmouth 52,300 Albany $51,300 York 49,900
Binghamton 44,100
Massachusetts Buffalo 46,900 Rhode Island
Boston $65,500 Duchess Co. 59,000 Newport $49,800
Brockton 57,700 Elmira 42,300 Providence/ 49,800
Fitchburg 53,100 Glens Falls 43,200 Warwick
Lawrence 60,800 Jamestown 38,400
Lowell 64,900 Nassau-Suffolk 76,500 Vermont
New Bedford 40,900 New York 56,200 Burlington $52,300
Pittsfield 43,600 Orange 54,400
Springfield 47,500 Rochester 52,400
Worcester 54,400 Syracuse 47,000
Southeast
Alabama Arkansas Florida
Anniston $41,500 Fayetteville $44,300 Daytona Beach 43,000
Birmingham 51,100 Fort Smith 37,300 Ft. Lauderdale 54,500
Columbus 41,700 Little Rock 47,100 Ft. Myers 47,300
Decatur 49,700 Pine Bluff 37,400 Ft. Pierce 49,600
Dothan 43,400 Texarkana 40,300 Ft. Walton Beach 44,700
Florence 42,700 Gainesville 51,400
Gadsden 38,200 District of Columbia Jacksonville 44,700
Huntsville 58,100 VA/MD/DC $87,800 Lakeland 43,400
Mobile 43,300 Melbourne 49,700
Montgomery 49,700
Tuscaloosa 45,300
Table 2-7
34
Southeast (Continued)
Maryland Bryan 43,600
Miami 43,700 Annapolis $55,600 Corpus Christi 41,000
Naples 59,100 Baltimore 63,100 Dallas 60,800
Ocala 38,300 Hagerstown 49,000 El Paso 34,900
Orlando 49,600 Suburban D.C. 82,800 Ft. Worth 57,400
Panama City 42,600 Galveston 52,100
Pensacola 42,600 Mississippi Houston 56,700
Sarasota 51,600 Biloxi $40,500 Killeen 39,000
Tallahasee 47,500 Jackson 50,200 Laredo 31,300
Tampa/ Longview 40,700
St. Petersburg 47,500 North Carolina Lubbock 43,600
West Palm Beach 56,600 Asheville $45,200 Mc Allen 25,500
Charlotte 57,100 Odessa 41,700
Georgia Fayetteville 40,700 San Angelo 41,300
Albany $42,400 Greensboro 51,000 San Antonio 43,100
Athens 45,400 Hickory 46,400 Sherman 42,100
Atlanta 63,100 Jacksonville 39,200 Texarkana 40,300
Augusta 46,600 Raleigh-Durham 62,800 Tyler 44,700
Columbus 41,700 Wilmington 45,600 Victoria 45,300
Macon 47,300 Winston Salem 45,500 Waco 43,800
Savannah 45,200 Wichita Falls 39,800
Spalding County 54,700 South Carolina
Walton County 54,700 Charleston 44,600 Virginia
Columbia 51,100 Charlottesville $57,000
Kentucky Florence 43,100 Danville 40,300
Clarksville $42,000 Greenville 48,700 Lynchburg 46,300
Evansville 49,700 Myrtle Beach 42,100 Norfolk/
Gallatin 47,100 VA Beach 49,300
Lexington 52,700 Tennessee Richmond 59,500
Louisville 51,500 Chattanooga $48,000 Roanoke 51,200
Owensboro 45,000 Clarksville 42,000 Suburban D.C. 82,800
Jackson 46,100 Warren 48,300
Louisiana Knoxville 48,700
Alexandria $36,000 Memphis 52,400 West Virginia
Baton Rouge 47,100 Nashville 58,800 Berkeley $47,800
Houma 36,900 Charleston 43,000
Lafayette 36,300 Texas Huntington 36,100
Lake Charles 41,900 Abilene $40,300 Jefferson 48,600
Monroe 37,100 Amarillo 43,000 Parkersburg 42,900
New Orleans 42,000 Austin 58,900 Wheeling 37,100
Shreveport 38,400 Beaumont 44,700
St. James Parish 36,800 Brazoria 56,100
Brownsville 27,900
Midwest
Idaho Peoria 53,200 Kokomo 55,700
Boise City $50,200 Rockford 55,300 Lafayette 54,700
Springfield 59,100 Muncie 47,900
Illinois St. Louis 56,500 South Bend 51,300
Champaign 54,600 Terre Haute 43,000
Chicago 67,900 Indiana
Davenport 51,800 Bloomington 49,600 Iowa
Decatur 49,600 Cincinnati 57,800 Cedar Rapids $59,400
Dekalb 60,400 Elkhart 54,000 Davenport 51,800
Grundy 64,300 Evansville 49,700 Des Moines 60,000
Kendal 73,600 Fort Wayne 54,500 Dubuque 51,200
Kankakee 52,900 Gary-Hammond 53,800 Iowa City 59,500
Lake County 59,500 Indianapolis 57,700 Sioux City 48,100
Waterloo 47,000
35
Chapter 2
Midwest (Continued)
Kansas Missouri Lima 47,600
Kansas City $57,700 Columbia $52,100 Mansfield 46,100
Lawrence 51,500 Joplin 40,400 Steubenville 38,100
Topeka 54,000 Kansas City 57,700 Toledo 53,000
Wichita 55,100 Springfield 45,200 Youngstown 44,300
St. Joseph 42,700
Michigan St. Louis 56,500 South Dakota
Ann Arbor $68,700 Rapid City $44,800
Battle Creek 45,100 Nebraska Sioux Falls 53,200
Benton Harbor 50,400 Lincoln $57,000
Detroit 63,200 Omaha 58,600
Flint 51,900 Sioux City 48,100 Wisconsin
Grand Rapids 56,400 Appleton $56,600
Jackson 49,400 North Dakota Eu Claire 46,800
Kalamazoo 50,300 Bismarck $49,200 Green Bay 58,000
Lansing 56,600 Fargo 50,900 Janesville 57,300
Muskegon 56,400 Grand Forks 45,400 Kenosha 53,700
Saginaw 51,700 La Crosse 49,500
Ohio Madison 64,700
Minnesota Akron $51,800 Milwaukee 61,400
Duluth $46,200 Canton 48,500 Racine 59,800
Minneapolis/ Cincinnati 57,800 Sheboygan 57,000
St. Paul 68,600 Cleveland 55,400 Wausau 54,000
Rochester 66,500 Columbus 57,300
St. Cloud 50,100 Dayton 55,900
Hamilton 57,800
West
Alaska Greeley 41,300 Portland 53,700
Anchorage $59,300 Pueblo 35,300 Salem 43,800
Arizona Hawaii Utah

Phoenix $53,100 Honolulu $59,600 Provo-Orem $46,500
Tucson 45,100 Salt Lake City/
Yuma 35,700 Montana Ogden 53,400
Billings $47,300
California Great Falls 40,000 Washington
Fresno $37,600 Bellingham $48,100
Los Angeles 52,100 Nevada Bremerton 49,800
Oakland 67,600 Las Vegas $50,700 Olympia 49,900
Orange County 69,600 Reno 57,300 Richland 48,200
Sacramento 52,900 Seattle 65,800
San Diego 53,700 New Mexico Spokane 44,100
San Francisco 74,900 Albuquerque $48,300 Tacoma 49,100
San Jose 87,000 Las Cruces 35,200 Vancouver 53,700
Santa Barbara 53,500 Santa Fe 59,300 Yakima 38,200
Santa Cruz 58,700
Santa Rosa 61,700 Oklahoma Wyoming
Vallejo 53,300 Enid $38,500 Casper $44,100
Ventura 68,500 Fort Smith 37,700 Cheyenne 44,700
Lawton 37,000
Colorado Oklahoma City 44,100 Note: Source FHA . Does not
Boulder $74,100 Tulsa 45,100 include non-metropolitan counties.
Colorado Springs 51,300 Some local areas may have
Denver 62,100 Oregon community lending income limits
Ft Collins 56,300 Eugene $41,700 higher than the standard 100% to
Medford 38,800 170% of median incomes.

36
- Lender can warrant18 compliance

• Freddie Mac Class III
- Project is complete and homeowners association has been in control for two years
- No additional phasing in the project
- 60% of the units must be owner occupied unless the LTV is 75% or less.
- 90% of the units have been conveyed or under contract to different individuals
- Minimum insurance coverage must be maintained
- Budget and reserves must be acceptable
- Lender can warrant compliance
• Fannie Mae Type A
- Project complete, no additional phasing
- Unit owners control association for one year
- 90% of the units have been conveyed to different individuals
- 60% of the project is comprised of owner occupied or second homes
- No more than 10% of the project is owned by a single entity
- No more than 10% commercial usage in the project
- Minimum insurance coverage must be maintained.
- Budget and reserves must be acceptable
- Lender can warrant compliance
New condominium and planned unit development projects which are not complete will typically
necessitate the direct approval of Fannie Mae or Freddie Mac. There are typically minimum owner occu-
pancy and presale requirements which can be met phase by phase as the project is built.
Fannie Mae also has a program to purchase mortgages secured by cooperative properties. These
cooperatives must be located in areas which have demonstrated market acceptance for the cooperative
form of ownership. Lenders can warrant compliance for up to 20% of the units in a project on a spot loan
basis for Fannie Mae Type 1 coops. Type 2 projects are directly approved by Fannie Mae and appear on
the Fannie Mae approved list. Many of the requirements mirror those established by Fannie Mae for
condominium projects (for example one entity cannot own more than 10% of the project).
Mortgage types offered

There is a wider variety of mortgages available through Fannie Mae and Freddie Mac than govern-
ment mortgage sources. It should be noted that Fannie Mae and Freddie Mac also purchase second trust
mortgages up to 50% of the limit for first trust mortgages. Generally, these seconds cannot be placed
behind a conforming first in a purchase transaction in order to exceed the legislated conforming purchase
limits. They may allow conforming seconds to lower the cash requirements for low-to-moderate income
programs (for example Freddie Mac Affordable Seconds)
• Fixed rate mortgages. Fixed rate mortgages typically are available from a 10 year to 30 year term.
Unlike FHA and VA mortgages, interest rates are typically offered in .125% increments; for example,
8.00%, 8.125%, and 8.25%. Generally 15 year mortgages will carry an interest rate approximately
.25% to .375% less than 30 year mortgages. Fannie Mae has offered commitments to lenders specifically
18
When a lender warrants compliance, the agency does not have to approve the project. The lender signs a warranty form which
attests to compliance with the standards.
37
Chapter 2
on 20 year and 10 year terms. The rates on 20 year mortgages are typically .125% below 30 year
rates and 10 year mortgages are approximately .125% below 15 year rates.
• Balloon mortgages. Fannie Mae and Freddie Mac both offer balloon mortgages, with the Fannie
Mae 7/23 and Freddie Mac 5/25 programs being the most popular. Usually, these require a greater
down payment (minimum 10%) and are not available for investor transactions. They are very popular
because interest rates are significantly below fixed rate/fixed payment mortgages. Fannie Mae also
offers a two-step program that is an ARM which offers a guaranteed right to refinance, or conversion
to a fixed rate. However, the higher interest rate of this program as compared to typical balloon
products has limited the two-step's popularity.
• Adjustable rate mortgages. Both Fannie Mae and Freddie Mac offer a wide variety of adjustable rate
mortgages. The more common adjustment periods would range from six months to three years and
they are typically based upon Treasury indices. There are many variations, for example CD and
Libor-indexed six month adjustables. There are variations in caps as well: some one year adjustables
may have one percent annual adjustment caps rather
than the typical two percent annual caps. Most A History Of Conforming Mortgage
adjustable programs require a minimum 10% down Limits
payment and are not available for investor transactions. 1 Unit 2 Units 3 Units 4 Units
Qualification standards for adjustable programs are 1989 187,600 239,750 290,000 360,450
more stringent than their fixed rate counterparts. Fannie 1990 187,450 239,750 289,750 360,150
Mae and Freddie Mac have a minimum qualification 1991 191,250 244,650 295,650 367,500
rate of 7% regardless of the starting rate of the 1992 202,300 258,800 312,800 388,800
1993 203,150 259,850 314,100 390,400
mortgage. If there is less than a 20% down payment
1994 203,150 259,850 314,100 390,400
on an ARM mortgage which allows annual adjustments
1995 203,150 259,850 314,100 390,400
of more than one percent, the program may qualify at
1996 207,000 264,750 320,050 397,800
the second year maximum rate, or 7%, whichever is 1997 214,600 274,550 331,850 412,850
higher. 1998 227,150 290,650 351,300 436,600
• Temporary buydowns. Most fixed rate and balloon 1999 240,000 307,100 371,200 461,350
mortgages can be offered with temporary buydowns 2000 252,700 323,400 390,900 485,800
as long as it is not an investor transaction. Fannie Mae 2001 275,000 351,950 425,400 528,700
will apply more stringent qualification ratios of 28/33,
Table 2-8
and typically the borrower cannot be qualified at less
than two percent below the note rate. If a compressed
buydown is offered (allows adjustments semi-annually instead of once per year), the qualification rate
is usually one percent below the note rate.
• Growing equity mortgages. The most popular growing equity mortgage (GEM) was offered for years
by Freddie Mac and was called the Equal program. In 1991 Freddie Mac eliminated this 15 year
program and another has yet to take its place at the present time.
• Reverse Mortgages. Under Fannie Mae's Home Keeper program.
• Rehabilitation and Construction-to-Permanent Mortgages. Under Fannie Mae's HomeStyle Program.
Maximum conforming mortgage amount

The maximum mortgage that Fannie Mae and Freddie Mac can purchase is indexed yearly, in tandem
with the median sales price financed with a conventional mortgage in October of each year.
38
The new conforming mortgage amount is announced in November of each year and is effective
January 1, of the following year. The current (2001) mortgage limits are as follows19:
1 Unit Properties: $275,000
2 Unit Properties: $351,950 Private Mortgage
Insurance Example
3 Unit Properties: $425,400
Sale price $100,000
4 Unit Properties: $528,700 Mortgage amount $95,000
Coverage required x 22%
The costs to obtain conforming mortgages Covered amount $20,900
Lender risk $74,100
Down payment. For owner occupied transactions a minimum Lender risk 75%
5% down payment is required. Programs exist which require a Mortgage amount $95,000
3% down payment for low-to-moderate income borrowers. A Up-front rate x 1.00
minimum 10% down payment is required for balloon and Up-front cost $950
adjustable rate mortgages, and a minimum 10% equity is required Mortgage amount $95,000
Annual renewal rate x 0.49
for most owner occupied refinance transactions. A minimum 20%
Annual renewal cost $465.50
down payment is required for second homes and 30% for investor ÷ 12
transactions. In 2000, both Fannie Mae and Freddie Mac both Monthly renewal cost $38.79
introduced zero down mortgage programs. The Freddie Mac no-
downpayment program is restricted to borrowers with a minimum Monthly Private Mortgage
700 credit score who invest 3% of their own funds and have a Insurance Example
minimum of two months payment in reserve after closing. Sale price $100,000
Loan-to-value x 90%
Conventional mortgage insurance. Fannie Mae and Freddie
Mortgage amount $90,000
Mac both require coverage from a private mortgage insurance Insurance rate x .52%
company if less than a 20% down payment is made. This insur- Annual insurance $468
ance protects the lender against default and coverage is required Monthly payment $39.00
that will protect the lender against any risk typically beyond a
75% LTV. In the example on the right, the mortgage insurance
would cover the first $20,900 of the loan amount. If the mort-
gage defaults, the lender would have to absorb losses if less than $74,100 is recovered in a foreclosure
transaction.
Generally, the cost of this insurance (MI), will vary according to the loan-to-value of the mortgage
and the mortgage product. The highest cost would be for 100% LTV mortgages. Costs can also vary
from one private mortgage insurance company to the next20 and for different regions of the country. In
most states, the State agency regulating the insurance industry must approve rate schedules. Monthly
costs will vary .32% to 1.04% of the mortgage.
The option exists to finance the mortgage insurance premium rolling the cost into the mortgage amount21
in a program which simulates the FHA mortgage insurance program. The advantage of this is saving cash
up-front and having the entire premium financed so that it can be deducted from taxes as interest.
19
Higher limits are effective in Alaska, Guam and Hawaii ($412,500; $527,925; $638,100; $793,050)
20
Examples of private mortgage insurance companies: General Electric Insurance (GEIMCO), PMI Mortgage Insurance (PMI), United
Guaranty Insurance (UGIC), Mortgage Guaranty Insurance (MGIC), Radian Guaranty, Republic Mortgage Insurance (RMIC).
21
Note that the loan-to-value including the mortgage insurance can never be above 95%. If the mortgage insurance causes the loan-to-value
to rise over 90% LTV, the qualification standards of a 95% mortgage will be utilized.
39
Chapter 2
Two new options were introduced to the mortgage insurance scene in 1993. One requires no up-
front premium, but carries a higher monthly insurance payment.22 This option is being offered by almost
all major mortgage insurance carriers and is called the monthly premium option (example previous page).
The second option is offered by many lenders. This program is called lender paid mortgage insurance
and it eliminates up-front mortgage insurance cost through a higher interest rate rather than increased
monthly insurance or mortgage amounts. The advantage of this program is as follows:
• No mortgage loan approval is required from a mortgage insurance company. It should be noted that
many lenders do have delegated underwriting authority from
mortgage insurance companies and therefore do not have to send
their mortgages to these companies for approval. Second Mortgage
(75-15-10 Mortgage)
• No up-front cash is required, even with as little as five percent
Sale price $100,000
down payment.
1st trust (75%) - $75,000
• There is no loss in equity due to increased mortgage amounts. 2nd trust (15%) - $15,000
• The total payment is tax deductible. Down payment (10%) $10,000
The main disadvantage of lender paid insurance is the fact that

the higher rate can never be eliminated from the mortgage payment even if the LTV of the mortgage
eventually drops below 80%.
Under the Homeowner's Protection Act of 1998 homeowners have the right to request cancellation of
private mortgage insurance when their equity reaches 20% of the original value of the home. When
equity reaches 22%, the lender must cancel the insurance automatically. For mortgages existing before
July 29, 1999, lenders must send an annual notice as to how the homeowner may apply for cancellation.
For these existing mortgages, the rules for dropping mortgage insurance will vary by lender and program.
The following represent typical guidelines for the elimination of mortgage insurance.
Elimination of private mortgage insurance. Other than making a down payment of 20% or more,
there are ways to eliminate the need for private mortgage insurance:
• Second mortgages. A second mortgage can be placed behind a purchase money first trust, as long as
the LTV of the first trust is no more than 80% and the combined loan-to-value of the first and second
trust (CLTV) can be no more than 95%. Rules for "Piggyback" Mortgages vary from lender to lender.
• Lender insured mortgages. Some lenders may charge a higher rate for their mortgage products and
use this rate premium to finance lender insured mortgages. Generally, a minimum 10% down payment
is required. These mortgages are not purchased by Fannie Mae and Freddie Mac and the mortgages
would be considered non-conforming. In recent years the prevalence of lender insured mortgages
has decreased dramatically.
Why would a borrower want to eliminate mortgage insurance in favor of paying a higher rate or pro-
curing a second trust?
• Mortgage insurance premiums are not tax deductible as is monthly mortgage interest.
• Each private mortgage insurance company has underwriting guidelines which may differ from Fannie
Mae and Freddie Mac. For example, perhaps the agency does not require a non-citizen to possess a
green card while most mortgage insurance companies have such a requirement. Or the agency might
permit lending within a condominium complex while the mortgage insurance company does not.
22
For example, a 95% LTV mortgage with the 1.00% up-front premium eliminated may have the monthly premium increased from
.49% to .63%.
40
Pr iv
Priv ate Mor
ivate tga
Mortga
tgagge Insur ance
Insurance
Typical Rates
Monthly Only Premium Schedule
30 Year Fixed 1% ARMS 2% ARMS 15 Year Fixed
At At At At
LTV Coverage Closing Monthly Closing Monthly Closing Monthly Coverage Closing Monthly
95 to 97 35% 0 .96% — — — — 30% 0 .73%
91 to 95 25% 0 .67% 0 .88% 0 .92% 25% 0 .56%
86 to 90 17% 0 .39% 0 .61% 0 .65% 12% 0 .23%
81 to 85 12% 0 .32% 0 .33% 0 .37% 6% 0 .12%
Financed Mortgage Insurance

30 Year Fixed 1% ARMS 2%-ARMS
LTV Coverage Refund Refund Refund
91 to 95 25% 3.30 3.60 3.80
86 to 90 25% 2.35 2.80 2.95
81 to 85 25% 1.90 2.20 2.40
Lender Paid Mortgage Insurance

30 Year Fixed Buydown ARM's 15 Year Fixed
LTV Coverage Rate Add-On Rate Add-On Rate Add-On Coverage Rate Add On
91 to 95 36% .90% 1.03% N/A 31% .67%
86 to 90 29% .58% .69% .83% 14% .25%
81 to 85 14% .35% .43% .43% 8% .23%
Notes:
• Coverage is the percentage of loan amount which will be covered against default. The coverage shown will reduce the lender's
exposure to a minimum of 75% of the sales price. The above costs and coverages are typical and will vary by company, product,
and jurisdiction. Temporary buydowns may be priced on a 1% ARM schedule, fixed rate schedule, or a separate buydown schedule
depending upon the company. Some example coverages shown (such as agency reduced coverages of 25% for 95 LTV 30 year
fixed) may require minimum automated underwriting score.
• Premiums for A- credit loans will be higher and may vary by credit score.
• Financed Mortgage Insurance entails a one time premium which is added to the mortgage amount. The total mortgage amount
including insurance may be limited to 95% LTV depending upon the program. Example: 2.00% premium with a mortgage amount
of $100,000. Total mortgage amount would be $102,000.
• Monthly Mortgage Insurance entails a monthly premium without any up-front costs. If the monthly premium is .62% on a $100,000
mortgage, the cost would be $620 annually or $51.67 monthly.
• Lender Paid Mortgage Insurance entails a higher interest rate paid without an increase in the mortgage amount. For example, if
the premium is .90% and the interest rate is 7.00%, then the borrower would pay 7.90% for the life of the mortgage.
• Partial Self-Insured Option. (after notes to Lend Paid Mortgage) This option was introduced by Fannie Mae and Freddie Mac in 1999
for conforming mortgages--
95% LTV 18% Coverage, .75%* Price Adjustment (monthly premium @.50%)
90% LTV 12% Coverage, .375%* Price Adjustment (monthly premium @ .34%)
* point adjustment can be converted to note rate adjustment- .75% would add approximately .15% to note rate.
Table 2-9
41
Chapter 2
Other costs associated with conforming mortgages. Unlike FHA and VA, lender fees are completely
negotiable on conforming mortgages, and it does not matter whether the purchaser or seller pays points or
lender fees as long as general seller contribution limits are not violated.
Qualification guidelines
Income qualification. The ratio method is employed on conventional mortgages with the most com-
mon ratios being 28/36. Fannie Mae will typically use 28/33 ratios on mortgages with a 95% loan-to-
value.
Community Home Buyer/Affordable Gold Programs. In recent years, Congress has directed Fannie
Mae and Freddie Mac to focus on programs which will help first time home buyers and other home buyers
with low to moderate incomes. These programs are restricted to borrowers whose incomes typically do
not exceed 115% of the median income of the particular region. Fannie Mae has recently adopted a limit
of 100% in most geographic areas with a special program which has no limit in designated areas. Ratios
for these programs will generally be more liberal than normal Fannie Mae and Freddie Mac underwriting,
usually 33/38. Fannie Mae also recently eliminated the back ratio constraint for these mortgages, opting
to take a broader view of the borrower's background.
Cash requirements. Conventional conforming mortgage programs generally require that the borrower
invest 5% of their own cash in any purchase transaction and have the equivalent of 2 months mortgage
payment in reserve after closing. This 5% can be borrowed as long as the purchaser can qualify for the
additional debt and the loan is secured by an owned asset. Beyond the 5% cash requirement, total cash
outlays can be lowered as follows:
• Gift. A gift from an immediate family member for closing costs. If the down payment is a minimum of
20%, then a gift can be procured for all cash requirements.
• Contributions. The seller can pay closing costs (not including prepaids) within the following limitations
of total seller contributions:
95% LTV 3% Maximum Seller Contribution
90% LTV or below 6% Maximum Seller Contribution
Investor Transactions 2% Maximum Seller Contribution
Seller's contribution maximum is based upon the sales price, not the mortgage amount.
• Reduced closing cost programs. Since the fees and rates are negotiable, lenders may offer programs
with no points or reduced closing costs coupled with a higher interest rate. These programs do not
increase the necessary down payment, thereby reducing the cash necessary for closing.
• Low-to-moderate income programs.The aforementioned low-to-moderate income programs require
only 3% from the purchaser's own funds, allow the remaining 2% from certain other sources and
require no cash reserves after closing. Programs have also been introduced with a 3% downpayment
and more recently (latter half of 2000), Fannie Mae and Freddie Mac have introduced programs that
require no downpayment and may not have maximum income limits. Depending upon the option
selected, affordable programs may also allow seconds to lower the down-payment requirements.
42
Co-borrowers. At a 95% LTV, co-borrowers must live in the property under conforming guidelines.
In addition, at lower LTVs there is a minimum ratio requirement of 38/43 for the owner occupant when
there is a co-borrower who does not live in the property.
Secondary financing. Second mortgages are permitted but the first mortgage may be limited to 75%
LTV and a minimum 10% down payment may be required. Secondary financing is not allowed under
most balloon mortgage programs. In addition, there are requirements for the type of second trust allow-
able:
• The second trust must not balloon in less than five years.
• The second trust cannot have more than a 30 year term.
• There must be regular payments required.
• There must be no deferred interest.
• For an open equity line, the amount of available credit will be used to calculate maximum CLTV or
combined loan-to-value of the first and second trust.
• No prepayment penalty is allowed.
• If the first trust is an ARM, then the second trust payments must be fixed.
• If the second trust is an ARM or has graduated payments, the payments may not increase more than
8% each year.
A second trust which meets these requirements and therefore is acceptable for placement behind a
conforming first trust mortgage is called a conforming second trust. In the past few years, programs have
proliferated that allow more liberal secondary financing. The most popular of these is a "80-15-5" that
requires only a 5% downpayment. Many lenders obtain exceptions from Fannie and Freddie to offer
these options--but overall requirements and costs may vary.
Conventional Non-Conforming
If we consider conventional non-conforming mortgages to be those which are not insured by FHA,
guaranteed by VA, issued under the authority of the Federal Bond Subsidy Act, or purchased by Fannie
Mae or Freddie Mac, then this category is the whole universe of mortgages which do not fit into the most
common categories. Since we are talking about a whole universe of mortgages, it is quite impossible to
summarize their common characteristics. What we will attempt to accomplish in this section is to list the
most common types of non-conforming mortgages and how they differ from their conforming counter-
parts:
• Jumbo mortgages. Mortgages which exceed Fannie Mae/Freddie Mac conforming loan limits are
usually referred to as jumbo mortgages. The vast majority of these mortgages are underwritten to
Fannie Mae and Freddie Mac guidelines and would require private mortgage insurance coverage
commensurate with conforming mortgages. Interest rates for jumbo mortgages may typically be
anywhere from .125% to 1.00% above conforming alternatives--though adjustable programs may
require no rate premium. A typical example of down payments required under a jumbo program:
5% to 350,000 15% to 550,000

10% to 450,000 20% to 750,000
43
Chapter 2
• Non “A” credit mortgages (subprime). Fannie Mae, Freddie Mac and most jumbo mortgage investors
purchase mortgages made to borrowers who have relatively good credit histories, stable income and
reasonable income qualification. Those who do not meet these criteria may be classified as B, C and
D credit borrowers. There are sources which focus on the purchase of these mortgages, usually at a
much higher interest rate and requiring a larger down payment than A credit mortgages. As the non-
conforming (B&C Lending) market has grown it has become easier to classify borrowers in accordance
within their category of credit. For example, the following might represent sample categories for a
non-conforming lender:
Mortgage Level Credit Score LTV Maximum Mortgage Delinquency

A Credit 620 95% 0x30
A- Credit 580 90% 1x30
B Credit 520 85% 3x30
C Credit 520 80% 60 day late allowed
D Credit N/A 75% 120 days past due maximum
Note: For each level of credit, the non-conforming rates would increase (B rates are higher than
A-). Mortgage delinquencies may be measured during the past 12 or 24 months. "Rolling 30s”
count as one delinquency. A "rolling 30” is more than one month which is late due to one
payment not being on time and the borrower not catching up. In other words, one payment
skipped may result in nine months of late payments, but only one "rolling 30.”
Non “A” credit mortgages are not limited to those with poor credit payment histories. They may
include borrowers who do not meet normal eligibility guidelines such as being self-employed for a
short period of time, non-resident aliens, investors with many investment properties and more. In
addition, in recent years Freddie Mac has moved into lending for A- level borrowers by offering
programs for lower credit scores at a higher "conforming" rate.
• Non-conforming properties. Non-conforming properties would include those located in condominium
projects not approved by major agencies, partial commercial usage, excess acreage, a high "land-to-
value" ratio, cooperatives, etc. Many local banks provide funding for non-conforming properties for
customers of those institutions.
• Self-insured/portfolio mortgages. In the past, many savings and loan institutions offered mortgages
which were not insured through conventional mortgage insurance companies. A higher interest rate
was charged to absorb the risk of insuring the mortgages through the savings institution. The savings
and loan crisis of the late 1980's greatly minimized the sources of mortgages which are self-insured or
otherwise originated to be held (for portfolio), though some sources still exist. The regulatory agencies
watch savings institutions carefully for the origination of non-conforming mortgage products that
could not be sold on the secondary markets if the need for liquidation of assets arises. These portfolios
are also subject to extreme risk as increases in market interest rates would make the assets less valuable.
• Non-conforming mortgage products. There are many mortgage products which are offered by mortgage
sources, but are not salable to Fannie Mae and Freddie Mac. Examples might include cost of funds
index (COFI) based adjustables with potential negative amortization and 30 year amortized mortgages
with 15 year balloons. Other examples might include conforming first trusts which have non-
conforming seconds: for example, conforming standards might require a "75-15-10". Non-conforming
44
mortgages may allow a "75-20-5" or even a "70-30". Non-conforming seconds have become a very
popular tool utilized to decrease down payments or eliminate mortgage insurance. The qualification
standards may or may not follow conforming guidelines. Generally, following these guidelines may
help in the eventual sale of these non-conforming mortgages in the secondary market after the mortgages
are seasoned.
Major Mortgage Source Comparisons

FHA VA CONFORMING
Eligibility One FHA loan per Borrower Veterans and active military Unlimited
Types of Owner occupied purchase Owner occupied purchase Owner occupied, second
Transactions and refinance and refinance homes, investor purchase
Rate reduction refinance Rate reduction refinance and refinance
for investors for investors
Types of Single family, PUDs, condos Single family, PUDs, condos Single family, PUDs,
Properties condos, coops
Mortgage Fixed rates, buydowns, Fixed rates, buydowns, Fixed rates, buydowns,
Types 1 year ARM, reverse ARMS, balloons
Maximum $132,000 to $239,250 $203,000 (1-4 Units) $275,000 (1 Unit)
Mortgage Amount (1 Unit) Regional Variation
Costs: 30 yr: 1.5% up-front/ Funding Fee: Insurance:
Insurance .50% monthly 2.00% up-front (100% LTV) .67% monthly
15yr: .25% monthly (more for 2nd time usage) (95% LTV/30 yr fixed)
Costs: Minimum 1.25% to 2.85% No down payment with 5% (principal residence)

Down Payment full eligibility 3% low-to-mod income
0% program available
Qualification 29/41 Ratios 41 Back ratio/ 25-33 Front ratio
Positive residual 33-38 Back ratio
Assumptions Owner occupants only with With credit approval24 Not typically. Some ARMs
credit approval23 are assumable with
credit approval
Misc. à 100% gift allowed à100% gift allowed à 3% of buyer's own
à No green card àMax seller contribution 4%26 cash required27
à Max seller contribution 6%25à No required reserves à Max seller contribution
à No required reserves à 90% LTV cash out refis 3% at 95% LTV
à 85% LTV cash out refis à 2 months PITI reserves28
à 75% LTV cash out refis
Table 2-10
23
After 12/15/89. Loans closed before that date require no credit approval except if a release of liability for the original mortgage holder is
desired. If the mortgage was closed after 12/1/86 and before 12/15/89, an investor may assume only if the LTV is paid down to 75%. Before
12/1/86 there were no limits on investor assumptions.
24
If the commitment was issued before 3/1/88 there is no credit approval required. There is always credit approval required for a substitution
of eligibility.
25
Buyer must invest 3% cash in the transaction.
26
Seller can pay typical closing costs and discount points for the purchaser in addition to the 4% limitation.
27
Low to moderate income programs can require as little as 3% from borrower.
28
Low to moderate income home buyer programs may not require reserves.
45
Types of Mortgages
3
Types of Mortgages
As the secondary market for mortgages has grown, so have the varieties of mortgages available to the
average consumer. Twenty years ago, the only choices would have been a 30 year fixed rate, a 15 year
fixed rate, and an adjustable rate mortgage. Today an applicant can walk into a mortgage company and
choose from five, ten, or even twenty mortgage products. This chapter will try to give some basis for
comparing and selecting among these products.
We will organize our discussion by categorizing all mortgages within three major group--
• fixed rate and fixed payment mortgages
• fixed rate hybrids: non-fixed payments and balloons
• adjustable rate mortgages.
Fixed rate/fixed payment mortgages

A fixed rate mortgage, occasionally abbreviated as FRM, is the simplest and the most common of all
mortgage instruments. During the past 10 years, fixed rate mortgages have ranged from a low of 30% to
a high of 80% of the total residential first trust mortgages originated in the United States. The volume of
fixed rate activity tends to increase as market rates decrease, which makes the higher payments of fixed
rates more affordable. The only variation among fixed rate mortgages is in the mortgage term. The term is
the life of a mortgage: the period of time over which the money is lent. To be considered fixed rate, the
mortgage must have two major characteristics:
• The interest rate and payments must be fixed over the term of the mortgage.
• At the end of the mortgage it must be paid off completely.
A mortgage which is paid off completely by the end of its term is said to be fully amortized. To
amortize is simply to decrease the principal balance on the mortgage on a monthly basis, or to pay down
the mortgage balance. An amortization schedule may be produced for any mortgage, laying out the
payments over the life of the mortgage. In this section we have illustrations of annual amortization
schedules for the most common fixed rate mortgage terms: 30, 20, and 15 years. Annual amortization
schedules show the principal reduction each year.
The example amortization schedules are based on a $100,000 mortgage because it provides an easy
basis for extrapolating to other mortgage amounts. If you are seeking a mortgage of $50,000, you can
simply divide all amounts shown in the chart by two. If you are seeking a mortgage of $150,000, then
multiply the amounts in the chart by one and one-half.
47
Chapter 3
Many applicants receive amortization

schedules when they apply for a mortgage. It Annual Amortization Table
is an important document which enables you 20 Year Ter m
to follow the progress in paying down the mort- $100,000 Loan Amount
9% Fixed Rate Loan
gage. It is also important to know how an am-
Total Total
ortization schedule is calculated. Too many bor- Monthly Annual Annual Remaining
rowers merely look at the schedule, but have Year Payment Principal Interest Balance
1 $899.73 $1,872.71 $8,924.00 $98,127.29
no idea how the interest is actually calculated. 2 $899.73 $2,048.38 $8,748.33 $96,078.91
To illustrate how a monthly amortization 3 $899.73 $2,240.54 $8,556.18 $93,838.37
schedule is calculated, we will manually com- 4 $899.73 $2,450.71 $8,346.00 $91,387.66
5 $899.73 $2,680.61 $8,116.10 $88,707.05
pute the first three months of a schedule. 6 $899.73 $2,932.07 $7,864.64 $85,774.98
7 $899.73 $3,207.12 $7,589.60 $82,567.87
Computation of an amortization 8 $899.73 $3,507.96 $7,288.75 $79,059.90
9 $899.73 $3,837.04 $6,959.68 $75,222.87
schedule 10 $899.73 $4,196.98 $6,599.74 $71,025.89
11 $899.73 $4,590.68 $6,206.03 $66,435.21
We will use a $100,000 mortgage with a 12 $899.73 $5,021.32 $5,775.39 $61,413.89
30 year term, at a 9% interest rate. First, we 13 $899.73 $5,492.35 $5,304.36 $55,921.54
need to know the monthly payment for this 14 $899.73 $6,007.57 $4,789.14 $49,913.96
15 $899.73 $6,571.13 $4,225.59 $43,342.83
loan. Calculating monthly payments is quite
16 $899.73 $7,187.54 $3,609.17 $36,155.29
complex, requiring either a special table or a 17 $899.73 $7,861.78 $2,934.93 $28,293.51
financial calculator. Using such a method, we 18 $899.73 $8,599.27 $2,197.44 $19,694.23
find that the monthly payment for this loan is 19 $899.73 $9,405.95 $1,390.77 $10,288.29
20 $899.73 $10,288.29 $508.42 $0.00
$804.62.29 Next, we need to find the monthly
interest rate by dividing the annual rate by 12 Table 3-1
(9% ÷ 12 = 0.75%). Since this is a fixed rate
mortgage, neither of these numbers will change
at all during the life of the loan.
Annual Amortization Table
To perform the amortization calculation for 15 Year Term
the first month, we take the loan amount and $100,000 Loan Amount
9% Fixed Rate Loan
multiply it by the monthly interest rate
($100,000 x 0.75% = $750). Thus $750 of the Total Total
Monthly Annual Annual Remaining
first month's payment goes to pay interest. Sub- Year Payment Principal Interest Balance
1 $1014.27 $3,305.34 $8,865.86 $96,694.66
tracting this amount from the payment reveals 2 $1014.27 $3,615.40 $8,555.80 $93.079.26
the portion that goes toward payment of the 3 $1014.27 $3,954.55 $8,216.65 $89.124.71
principal ($804.62 – 750 = $54.62). We now 4 $1014.27 $4.325.51 $7,845.68 $84.799.20
5 $1014.27 $4,731.28 $7,439.92 $80.067.92
subtract this amount from the original loan 6 $1014.27 $5,175.10 $6,996.10 $74,892.82
amount to find how much principal remains as 7 $1014.27 $5,660.56 $6,510.63 $69.232,25
8 $1014.27 $6,191.56 $5,979.64 $63,040.69
of the end of the first month ($100,000 – 54.62 9 $1014.27 $6,772.38 $5,398.82 $56,268.31
= $99,945.38). 10 $1014.27 $7,407.67 $4,763.53 $48,860.64
11 $1014.27 $8,102.56 $4,068.64 $40,758.08
We repeat this procedure for the second 12 $1014.27 $8,862.64 $3,308.56 $31,895.44
month. The interest paid this month is calcu- 13 $1014.27 $9,694.01 $2,477.18 $22,201.43
14 $1014.27 $10,603.38 $1,567.82 $11,598.05
lated from the new principal balance and the 15 $1014.27 $11,598.05 $573.15 $0.00
29
Note: Appendix A contains a table of interest rate factors
which will enable you to quickly calculate a payment for 30,
20, or 15 year mortgages. Table 3-2
48
Types of Mortgages
monthly interest rate ($99,945.38 x 0.75% =

$749.59). Subtracting the interest from the pay-
ment gives the principal paid in the second
month ($804.62 – 749.59 = $55.03). Subtract- Fixed Rate Monthly Payments
ing this from the principal gives the principal 9.0% Interest/$100,000 Mortgage
remaining as of the end of the second month Term Total Principal Interest
($99,945.38 – 55.03 = $99,890.35). Yrs. Payment Payment Payment
15 $1014.27 $264.27 $750
And the third month— 20 $899.73 $149.73 $750
30 $804.62 $54.62 $750
Interest paid $99,890.35 x 0.75% = $749.18
Principal paid $804.62– 749.18 = $55.44 Table 3-4
Principal remaining $99,890.35– 55.44 = $99,834.91
Now that we understand how amortization

schedules are derived, we can appreciate how Annual Amortization Table
30 Year Term
computers and sample amortization schedules $100,000 Loan Amount
eliminate the tedium of having to go through 9% Fixed Rate Loan
the above process for each month of a 360 Total Total
month (30 year) loan! Monthly Annual Annual Remaining
Year Payment Principal Interest Balance
1 $804.62 $683.20 $8,972.27 $99,316.80
Fixed loan alternatives 2 $804.62 $747.29 $8,908.19 $98,569.52
3 $804.62 $817.39 $8,838.09 $97,752.13
We previously mentioned that fixed rate 4 $804.62 $894.06 $8,761.41 $96,858.07
loans are most commonly available in 15, 20, 5 $804.62 $977.93 $8,677.54 $95,880.14
and 30 year terms. Of these three, which is the 6 $804.62 $1,069.67 $8,585.80 $94,810.47
7 $804.62 $1,170.01 $8,485.46 $93,640.46
most popular and what advantages does one 8 $804.62 $1,279.77 $8,375.71 $92,360.69
have over the other? The 30 year mortgage is 9 $804.62 $1,399.82 $8,255.65 $90,960.87
easily the most popular fixed rate mortgage, 10 $804.62 $1,531.13 $8,124.34 $89,429.74
averaging lion's share of the fixed rate market 11 $804.62 $1,674.76 $7,980.71 $87,754.98
12 $804.62 $1,831.86 $7,823.61 $85,923.12
even in times of low market rates that have made 13 $804.62 $2,003.71 $7,651.77 $83,919.41
15 year mortgages more affordable. The source 14 $804.62 $2,191.67 $7,463.80 $81,727.75
of this popularity is simple: the 30 year fixed 15 $804.62 $2,397.26 $7,258.21 $79,330.49
rate mortgage requires the lowest payment of 16 $804.62 $2,622.14 $7,033.33 $76,708.35
17 $804.62 $2,868.11 $6,787.36 $73,840.23
the three. More of the payment goes to interest 18 $804.62 $3,137.16 $6,518.31 $70,703.07
(and less to principal), maximizing the tax de- 19 $804.62 $3,431.45 $6,224.02 $67,271.62
duction. In comparison, the 15 year mortgage 20 $804.62 $3,753.35 $5,902.13 $63,518.27
would have a higher payment, a lower interest 21 $804.62 $4,105.43 $5,550.04 $59,412.84
22 $804.62 $4,490.55 $5,164.92 $54,922.28
deduction, and faster payoff of the principal. 23 $804.62 $4,911.80 $4,743.67 $50,010.49
Thus, the purpose of a 15 year mortgage is early 24 $804.62 $5,372.56 $4,282.91 $44,637.93
payoff and interest savings over the mortgage 25 $804.62 $5,876.54 $3,778.93 $38,761.39
term. 26 $804.62 $6,427.80 $3,227.67 $32,333.58
27 $804.62 $7,030.77 $2,624.70 $25,302.81
Table 3-3 compares the breakdown of the 28 $804.62 $7,690.31 $1,965.16 $17,612.50
first month's payment for each of the three terms. 29 $804.62 $8,411.71 $1,243.76 $9,200.79
30 $804.62 $9,200.79 $454.68 $0.00
This chart clearly illustrates the immediate dif-
ferences between the various fixed rate mort-
Table 3-3
49
Chapter 3
gages. Each has the same initial monthly interest but Comparison of Fixed Rate Mortgages
the 15 year mortgage has an extra payment of $209.65
which entirely goes to pay off the principal. While the 7% Investment Interest
$100,000 Loan Amount
interest payment is the same for the first month under 9% Fixed Rate Loan
each mortgage, the interest paid monthly will reduce
Mortgage Term in Years
much more slowly under the 30 year instrument.
30 20 15
Table 3-5 illustrates interest savings and payment Monthly $805 $900 $1,014
comparisons for each of these mortgages. Note that we Payment
have made payment and savings comparisons from Extra $0 $95 $210
Payment
more than one angle. One can solely look at the interest Total $289,664 $215,934 $182,568
savings and payment savings over the life of the mort- Payments
gage—this is a perfectly legitimate comparison. In this Extra Pmt. $0 $22,825 $37,736
Over Term
instance, we can see that the 15 year mortgage saves Interest $0 $73,730 $107,096
over $100,000 in interest over its 15 year term (com- Savings
pared to the 30 year alternative). Also note that the 20 Total Savings $0 $50,905 $69,360
year mortgage saves over $70,000 over its 20 year term Investment $0 $26,709 $27,759
Interest
(again, compared to the 30 year mortgage).
Adjusted $0 $24,196 $41,601
The 20 year mortgage saves 68% of the interest of Savings
a 15 year mortgage, using a 30 year mortgage as a basis Table 3-5

of comparison. Yet the additional payments required for
a 20 year mortgage are only 45% of the additional pay-
ments for a 15 year mortgage ($95 extra vs. $209). How can this be? It is because the prepayment effect
reaches a point of diminishing returns around the 20th year. As you shorten the mortgage below 20 years,
it gets harder and harder (requires greater extra payments) to shorten the life of the mortgage. For ex-
ample, a 10 year payoff would require an extra payment of $462.14 per month as compared to the 30 year
payment of $804.62. In other words, it takes an extra $209 per month to reduce the term from 30 to 15
years, but another $253 each month to reduce the term from 15 to 10 years.
The monthly prepayment chart (Table 3-6) illustrates this concept quite vividly and could be very
helpful if you are considering prepaying an existing mortgage. It shows that $20 of extra payment on a
$100,000 mortgage saves three years off the term of the mortgage. It takes $50 to achieve the next three
years of savings. Each level of extra payment achieves less results. In comparing a 20 year mortgage to a
15 year mortgage, we achieve 70 percent of the result for 45 percent of the extra payment, making the 20
year mortgage a more efficient prepayment instrument.
However, these numbers change somewhat when we factor in the effect of interest income which
could be earned by not paying the extra payment of a 20 or 15 year mortgage. If one chose to make the
lower payments of a 30 year mortgage, theoretically one could place the extra payment in an investment
account on a regular basis and earn investment income on that money. Tables 3-4 and 3-5 impute a rate of
investment income of 7%, which is reasonable for the long term. We then subtract the interest income
from the interest savings.
We do not project the investment income beyond the term of each mortgage—conceptually we could
show extra savings by investing funds in years 16 through 30 on the 15 year mortgage, because payments
are no longer being made. Our calculation solely shows the savings while the mortgage instrument is in
existence—and in effect cuts the advantage of the 15 and 20 year mortgages by over half.
50
Types of Mortgages
Effect of Monthly Prepayment

$100,000 Loan at 9%, 30-year Amortization, 7% Investment Interest
Extra Principal &Months to Years to Total of Interest Extra Pmt. Invest. Adjusted
Payment Interest Payoff Payoff Payments Savings over Term Interest Savings
$ 0 $ 805 360 30.00 $289,664 $ 0 $ 0 $ 0 $ 0
$ 20 $ 825 322 26.79 $265,141 $ 24,523 $ 6,431 $ 12,390 $ 5,702
$ 50 $ 855 281 23.42 $240,225 $ 49,439 $ 14,054 $ 21,337 $ 14,047
$ 75 $ 880 256 21.36 $225,422 $ 64,242 $ 19,220 $ 25,004 $ 20,018
$100 $ 905 236 19.70 $213,870 $ 75,794 $ 23,642 $ 27,024 $ 25,128
$150 $ 955 206 17.18 $196,769 $ 92,895 $ 30,918 $ 28,647 $ 33,330
$200 $1,005 184 15.31 $184,546 $105,118 $ 36,739 $ 28,776 $ 39,603
Table 3-6
Before leaving our comparison of fixed rate, fixed payment instruments, we must cover three
additional points:
• Interest rates. Though our comparison chart compares the fixed rate instruments at the same interest
rate of 9.00%, 15 year mortgages are generally at a rate which is approximately 0.25% below 30 year
mortgages. In other words, we could have just as easily compared an 8.75%, 15 year mortgage to a
9.00%, 30 year mortgage. This difference in interest rates will actually decrease the extra payment of
a 15 year mortgage by approximately $15 each month.
• Prepayment penalties. Many mortgage applicants ask whether they can prepay their mortgage without
incurring some form of prepayment penalty. This penalty is a sum of money which must be paid if the
mortgage is paid off before the term is up or even paid down faster than the amortization schedule
requires. Prepayment penalties are no longer common in the mortgage industry--although they have
made somewhat of a comeback in recent years. Mortgages sold to VA, FHA, Fannie Mae or Freddie
Mac generally cannot carry these penalties.
• Mortgage payments. With our chart examples comparing the payment characteristics of a mortgage,
we would do well to spend a few minutes giving our readers the ability to figure the payment. On the
inside cover of the book, there is a payment factor chart which gives the payment factors for 30, 20
and 15 year mortgages at a variety of interest rates. These factors are the payment factors per $1,000;
one need only multiply by the mortgage amount.
Actually, the factors shown are short factors, which Mortgage factors example
are abbreviations of factors which are many decimal The 30 year factor for an 8% mortgage is 7.34.
Therefore, the monthly mortgage payment is
places long. This means that the payments calculated $734.00 for a $100,000 mortgage (7.34 x 100).
with the short factors may be as much as one dollar
per month off from the exact number. This is a level of
inaccuracy that we are willing to accept in the interest of simplifying the calculations.
The bi-weekly mortgage

A relatively new phenomenon in the world of mortgage finance is the bi-weekly mortgage. The bi-
weekly mortgage was imported from Canada and takes advantage of new pay patterns of the American
population. Many years ago workers were paid either weekly or monthly. Now more and more people
are paid every two weeks. The concept is to make one-half of what would otherwise be your monthly
mortgage payment every two weeks.
51
Chapter 3
When one makes one-half of a monthly The Bi-Weekly Advantage Bi-Weekly

mortgage payment every two weeks, one Mortgage Example
actually makes an extra monthly mortgage Extra
Payments • $100,000 mortgage
payment each year: • 9% interest rate
Monthly pmt. $804.62
• There are 52 weeks in one year. Bi-weekly pmt. $402.31
• Therefore, every other week would be Extra yearly pmt. $804.62
26 mortgage payments (one-half of one Payoff in:
527 bi-weekly pmts.
month each). 263 months
• There are 12 months in one year. 22 years
Increased monthly
• If one were to make one-half of each payment to achieve same
mortgage payment, one would then payoff:
make 24 payments in one year $67.05 per month for
$871.67 total payment
• Therefore, you are making two extra
one-half mortgage payments, or one
month extra each year.
The result of this extra mortgage pay-
ment each year? The bi-weekly is a fixed 26 bi-weekly 12 monthly
rate/fixed payment mortgage which pays off
in approximately 22 years. Figure 3-1
The bi-weekly mortgage is simply a convenient way to match your personal pay method with an early
payoff of your mortgage. There are a few disadvantages of bi-weekly mortgages:
1. The secondary market for bi-weekly mortgages has not really developed. Therefore, one is not likely
to receive the benefit of a lower interest rate for the shorter term of this mortgage. In other words, bi-
weekly mortgages are more likely to be priced as 30 year instruments rather than 15 year mortgages.
2. The 26 payments each year will cause more work for a mortgage servicer. The mortgage servicer
actually receives the mortgages payments each month, applies the principal, pays real estate tax bills
when they are due, etc. Most mortgage companies offering a bi-weekly option will require that the
mortgage payment be transferred directly from the bank of the borrower. This is called direct payment
and is similar to having your paycheck direct deposited in your bank account. Though many people
prefer this option for paying their mortgage because of the convenience, others prefer to have the
flexibility of mailing the payment during the 15 day grace period after which a mortgage is due. This
period is called a grace period because the mortgage servicer will not charge a late payment until the
mortgage is actually 16 days late. With the bi-weekly option, you lose payment flexibility.
Finally, companies have developed programs which will offer to convert your present mortgage to a
bi-weekly option. These companies are not making new mortgages—they are simply arranging for a
different payment schedule on your present mortgage. Before paying a fee for such a service, bear in
mind that you can just as easily add an amount to each monthly payment yourself in order to achieve the
same prepayment effect as the bi-weekly mortgage. If the charge is $500, then you could have funded
several months of extra payments in the above bi-weekly example.
52
Types of Mortgages
Fixed rate hybrids

The category of fixed rate hybrids includes all fixed rate mortgages which either do not have a fixed
payment or do not pay off completely at the term of the mortgage (are not fully amortized). We will
further subdivide this classification into subcategories:
• Balloon mortgages
• Graduated payment mortgages (GPMs)
Balloon mortgages
Balloon mortgages are usually fixed rate and fixed payment mortgages which do not amortize com-
pletely. Regular monthly payments are made during a certain specified time interval, and at the end of that
interval a lump sum payment of all remaining principal is due. Balloons are also called bullets or calls,
referring to the one time payment.
For example, a 30 due in 5, 30/5, or 5/
25 mortgage would have payments which
Annual Amortization Table
are amortized over 30 years, but with a 30 Year Amortization, 5 Year Term
balloon payment at the end of the fifth year. $100,000 Loan Amount
9% Fixed Rate Loan
That balloon payment would include any
principal due at the end of the fifth year. Total Total
Table 3-7 gives an example of this type of Monthly Annual Annual Remaining
Year Payment Principal Interest Balance
mortgage instrument. Note that this loan is 1 $804.62 $683.20 $8,972.27 $99,316.80
identical to a 30 year fixed rate loan for 2 $804.62 $747.29 $8,908.19 $98,569.52
the first four years. The fifth year is also 3 $804.62 $817.39 $8,838.09 $97,752.13
4 $804.62 $894.06 $8,761.41 $96,858.07
the same, up until the very last payment 5 $804.62 $96,858.07 $8,677.54 $0.00
(the 60th payment). That payment is the
sum of the normal $804.62, plus the entire Table 3-7
remaining principal of $95,880.34, for a
total of $96,684.96!
Why would anyone choose such a financing instrument? Since the lender need only guarantee the
interest rate for five years, there is less risk if rates should later increase. That lower risk means that the
lender can offer the balloon loan at a lower interest rate and payment.
By opting for the shorter term instrument, the lower payment helps one qualify for a larger mortgage.
Even if qualification is not an issue, the mortgage payment becomes more affordable. Those opting for
this mortgage instrument would be gambling on either moving or refinancing before the five year term is
complete. But what if there comes a recession which prevents resale of the property (moving) and the
owner loses his/her job and cannot refinance? The balloon instrument also carries a risk which comes with
the reward of lower rates and payments.
Freddie Mac and Fannie Mae have addressed this risk in making balloon products very popular
financing instruments in the past several years. Each carries a conditional right to refinance. This condi-
tional right to refinance enables the applicant to convert the mortgage to a fixed rate for the remaining
term of the mortgage after the balloon occurs. The rate is fixed according to a formula which is set against
53
Chapter 3
whatever that agency's fixed rates are at the time of conversion.30 The right to refinance is called
conditional because certain conditions must be met in order to give the borrower a right to convert to a
fixed rate:
• The property must remain occupied by the owner;
• No payments can be late by 30 days or more during the past year;
• No liens can be placed against the property (for example, a second trust);
• The rate of conversion can be no more than 5.0% over the current note rate or the lender can
refuse conversion31;
• A written request must be made to the mortgage holder.
Even with the conditional right to refinance, some areas have found balloon programs not readily
acceptable in the marketplace. The term balloon is associated with a risk and, especially in areas of limited
mobility, the risk does not sell well among conservative elements of the population. Therefore, Fannie
Mae has released an ARM mortgage called a Two-Step®. The Two-Step® mortgage removes the condi-
tions to refinance and make the conversion to a fixed rate automatic within 6.00% of the original note rate.
Because of the automatic right to refinance or convert, the Two-Step® mortgages carry a higher interest
rate than the balloon products.
Graduated payment mortgages

A graduated payment mortgage, also known as a GPM, is a class of fixed rate mortgages which has a
fixed rate, but also a payment that can vary during the term of the mortgage. As opposed to an adjustable
rate mortgage that typically has a rate and payment which varies over the term of the mortgage, a gradu-
ated payment mortgage has payment variations that are known at the inception of the mortgage term:
i.e., the borrower will know what his or her payments will be over the life of the mortgage even though
the payments are changing. Payment changes on an adjustable rate mortgage will typically vary in accor-
dance with future changes in interest rates and therefore are unknown.
There are two distinct types of graduated payment mortgages which we will address in this section:
• Growing equity mortgages (GEMs)
• Temporary buydown mortgages
Growing equity mortgages

Growing equity mortgages, or GEMs, increase their rate of mortgage payoff with each increase in
payment. Therefore, with a GEM one might start with 30 year amortization but wind up paying off the
mortgage in less than 30 years. Or, the loan may start with a 15 year amortization but at a payment which
is much lower than attributed to prevailing 15 year market rates. In the past Freddie Mac offered the Equal
Program. The Equal program carried 15 year amortization at a below market rate and payment increases
equal to 7.5% of the previous year's payment.
30
The formula for conversion to fixed rate offered in the Fannie Mae 7 Year Balloon Product is the Fannie Mae's required net yield for 30
year fixed rate mortgages subject to a 60-day mandatory delivery commitment, plus .5%, rounded to the nearest .125%. Freddie Mac uses
an identical formula.
31
Many borrowers feel that this cap is protecting the borrower such as a life cap would on an adjustable rate mortgage. Actually, the option
not to convert under high market rate conditions would be at the lender's discretion.
54
Types of Mortgages
With GEMs, you are starting with the equivalent 30 year fixed rate payment and ending with a
payment which is higher than the initial 15 year payment would have been. The theory here is simply:
Delay of pain
Many would like to have the equity build-up of a 15 year mortgage, but almost no one wants to deal
with the higher payments. Growing equity mortgages allow one to start at 30 year amortization and
graduate to 15 year amortization, delaying the pain of higher payments for future years. Even a 4% cost
of living income increase would be almost double the effect of a 7.5% increase in mortgage payment.
Thus, the mortgage is increasing more slowly than even conservative income growth. GEMs are obvi-
ously not a mortgage for those with incomes that are likely to remain fixed in future years.
Despite the fact that GEM programs make sense for those who would like to pay off a mortgage in less
than 30 years but cannot afford the high initial payments, this mortgage alternative has become much less
available since Freddie Mac ended their purchase of the Equal Program. It is still possible to create a
similar mortgage instrument utilizing a temporary buydown.
Temporary buydown mortgages

To buy down a mortgage is to lower the interest rate. A
1-0 Buydown
$804.62 $804.62 $804.62 $804.62
temporary buydown would lower the interest rate during a cer-
Monthly Payment
tain period of the mortgage's term, usually the first few years.
The purpose of a temporary buydown is to make the payments
affordable during the early years of the mortgage, allowing the
$733.76
borrower's income to grow into the higher payment of later
years. Unlike a growing equity mortgage, the purpose of a tem-
porary buydown is not necessarily to delay the pain of a quicker
payoff of the mortgage balance, though temporary buydowns 1 2 3 4 5
can be used on 15 year instruments to accomplish the same Year
purpose as a GEM. The temporary buydown is typically used
to help a purchaser qualify for a larger mortgage amount—
similar to the use of an adjustable rate or balloon mortgage. 2-1 Buydown
The advantage of a temporary buydown over an adjustable rate $804.62 $804.62 $804.62
mortgage is that the long term interest rate and payment of a

temporary buydown is fixed which adds security. In short, a
Monthly Payment
temporary buydown of a fixed rate mortgage gives many of $733.76
the short term advantages of an adjustable with the long term

security of a fixed rate.
$665.30
A temporary buydown is quite simple:
-9.0% 30 year fixed rate $100,000 mortgage 1 2 3 4 5
Year
-A 1.0% buydown would have an 8.00% rate for one year.
Therefore, the mortgage would be:
Figures 3-2 & 3-3
• 8.0% for year 1 (payment $733.76 for the first 12 months)
• 9.0% for years 2-30 (payment $804.62 for the last 348 months)
55
Chapter 3
This example is called a 1-0 annual buydown. The interest rate is bought down 1.0% for one year.
The buydown is typically named after the extent of the buydown: a 2-1 buydown would lower a 9.0%
fixed rate to 7.0% in the first year and 8.0% in year two:
• 7.0% for year 1 (payment $665.30 for the first 12 months)
• 8.0% for year 2 (payment $733.76 for the second 12 months)
• 9.0% for years 3-30 (payment $804.62 for the last 336 months)
How much does a buydown cost?

It stands to reason that the lower payments and interest rate of a temporary buydown does not come
without a cost. Calculating the actual cost of a temporary buydown is also very easy. One would simply
calculate the difference in payments over the period of the mortgage in which the interest rate is lowered.
To illustrate, let's return to the examples already brought forth, using the $100,000 loan amount at a 9%
rate with a 30 year term. First, the 1-0 buydown:
Expressed in terms of points, the cost would be: $850.20 ÷ $100,000, or 0.85 points. 32
Now, for the 2-1 buydown:
Monthly Payment at Difference

Year Payment at 9% Buydown Rate Times 12
1 $804.62 $733.77 (8%) $850.20
Expressed in terms of points, the cost would be $2,522.04 ÷ $100,000, or 2.52 points.
Monthly Payment at Difference

Year Payment at 9% Buydown Rate Times 12
1 $804.62 $665.30 (7%) $1,671.84
2 $804.62 $733.77 (8%) $850.20
Total $2,522.04
It should be noted that the lower payments may not be the only costs associated with a temporary
buydown. These are merely the cost of subsidizing the payment over the period of time of the buydown.
These extra points are placed into an escrow account so that the actual payments can be supplemented
during the term of the buydown. For this reason, a temporary buydown is sometimes called a subsidy. The
cost of this subsidy may not cover the full cost of the buydown because the loan may carry a premium in
the secondary market. The investor purchasing the mortgage knows that the borrower is not making the
full required payment in the early years of the mortgage and may have been qualified at the lower
payment. This increases the risk of default over a fixed rate-fixed payment mortgage and makes the
mortgage worth less in the secondary market (or increases its costs in terms of points).
A second factor decreases the loan's value in the secondary market. The eventual fixed rate on a
temporary buydown is likely to be higher than market fixed rates. Therefore, the borrower is more likely
32
A point is a cost equal to 1% of the loan amount.
56
Types of Mortgages
to refinance out of the instrument after the fixed rate is achieved. We say that this type of mortgage
instrument is more likely to prepay and therefore carries less servicing value.
Fortunately, temporary buydowns are now widely acceptable on mortgage markets, making these
secondary premiums quite rare. The one exception is for FHA and VA mortgages because GNMA has
directed these mortgages to be placed in a special pool (called a GNMA II Pool). The effect upon the cost
of FHA and VA buydowns? FHA and VA mortgages that carry temporary buydowns can cost up to one
point more than their fixed rate/fixed payment counterparts. This extra cost is in addition to the actual cost
of the buydown.
There are several other variations of temporary buydowns in addition to the popular 1-0 and 2-1
examples already brought forth:
• 3-2-1—A mortgage which is bought down 3.0% the first year, 2.0% the second year and 1.0% the
third year is certainly going to be comparatively expensive. Such a deep buydown will cost over five
points and is typically offered only by sellers and builders endeavoring deep concessions to dispose
of a property. In addition, many lenders will not qualify the borrower at the a first year payment rate
which is in excess of 2.0% below the fixed rate33 of the mortgage. This is true of FHA mortgages, with
VA mortgages being even more restrictive.34
Example of an “Odd”
• Odd buydowns—The buydowns we have described up to this point
Buydown
involve buying down the note rate a full percentage point each year. It
is possible to buy the note rate down less than a full percentage point. Note Rate: 9%
Buydown Type: 1.5%-0.5%
There is no rule which precludes such odd buydowns as long as one
Rate Year 1: 7.5%
basic rule is followed: Each year the rate of the mortgage cannot increase Year 2: 8.5%
more than 1.0%. The advantage of odd buydowns is the ability to
customize a mortgage to the needs of an individual borrower. If the
purpose of the temporary buydown is to help a home purchaser qualify for a larger sales price, yet a
full buydown of 2% below the note rate is not needed, then a 1.5% buydown the first year will be less
costly.
• Compressed buydowns—The buydowns we have introduced have rate increases each year of the
mortgage. Annual buydowns are overwhelmingly the most common class of temporary buydowns.
In the past, temporary buydowns have been introduced that allow rate increases every six months.
These are called compressed buydowns. Because the period of the buydown is cut in half, so is the
cost of the buydown. For example, a 2-1 buydown would cost just over 1.25 points instead of just
over 2.5 points. Of course the borrower would be subjected to much more rapid payment increases.
Knowing this, many lenders and agencies will not qualify the borrower at the bought down rate
because the mortgage can increase more than 1.0% each year. Compressed buydowns are currently
not a popular mortgage alternative.
33
The fixed rate of a mortgage bought down is referred to as the note rate, or the rate which is contained on the legal document (note) which
sets out the terms of the loan. Anytime there is a mortgage which is a non-fixed payment, we refer to the note rate as the eventual rate of the
mortgage or the rate upon which the mortgage is based.
34
Current VA rules preclude using a temporarily bought down rate to qualify any borrower unless there is clear evidence that the income will
increase. The lower payment can be used to offset a borrower's debt payment which will expire before the mortgage reaches the note rate.
57
Chapter 3
Lender subsidized buydowns

To fully explain the concept of a lender subsidized buydown we would have to delve into the world
of mortgage costs and the secondary market. We will briefly explore the purchaser's view of the lender
subsidized buydown here.
The advantages of a temporary buydown are quite clear:
1. Starting at a lower rate and payment than prevailing fixed rate mortgages;
2. Increasing payments are limited to the early years of the mortgage; and
3. Long term fixed rate and payment security.
The one disadvantage is also quite clear: the cost of the buydown. As seen earlier, a typical 2–1
buydown on a 30 year fixed rate mortgage can cost over 2.50 points. The cost of these extra points can be
borne by the seller or the purchaser in a real estate transaction. Because a fixed rate mortgage already may
have points associated with obtaining the mortgage, the total cost can be quite high. If one is opting for a
temporary buydown, it would be an advantage to buy the rate down from a rate that carries less points:
2-1
Starting Rate Fixed-Rate Quote Buy-down Cost Total Cost
(percent) (percent & points) (points) (points)
6.75% 8.75% & 3 + 2.5 = 5.5
7.00% 9.00% & 1 + 2.5 = 3.5
7.25% 9.25% & 0 + 2.5 = 2.5
7.50% 9.50% & -1 + 2.5 = 1.5
In this example, if the seller were paying two points as a sales concession to persuade the purchaser to
buy the home, the purchaser might opt for a 30 year fixed rate at 8.75%. If one were looking for a 2–1
buydown, the likely choice would be a 9.0% fixed rate. What if the seller was not paying any points, and
the purchaser was very short on cash and could not afford to pay points as well? In most cases, we can
then continue to buy up the fixed rate to lower the total points of the buydown. As we increase the note
rate, the points actually are reduced to zero. Further increasing the rate above prevailing interest rates (up
to 9.50% in this example) actually reduces the points to a negative number. These points are credited to
the purchaser, reducing the points required for the buydown.
The example at 9.50% illustrates the concept of the lender subsidized buydown. The total cost of the
mortgage in terms of points is less than the cost of the buydown. The 7.5%–8.5%–9.5% buydown has
a total cost of 1.50 points, or one point less than the total cost of the buydown. When the total cost of the
mortgage is actually less than the cost of the buydown, the mortgage is called a lender subsidized buydown
because the lender is actually supplying some of the points necessary for the escrow of the buydown
funds. The lender will be reimbursed for these funds when the loan is sold in the secondary market at a
premium. It should be noted that there is a point of diminishing returns as one moves the rate above
market. There will be less of a point credit at higher rates because the servicing value of the loan will
diminish. Why pay to own a loan that is more likely to refinance because of higher-than-market rates?
Adjustable rate mortgages

The last classification of mortgage types involves mortgages which have interest rate changes over
time. These are called adjustable rate mortgages, adjustables, ARMs, or AMLs. Adjustable rate mortgages
are more complex than their fixed rate/fixed payment counterparts because of these rate changes.
58
Types of Mortgages
HISTORY OF MAJOR ARM INDICES
ONE YEAR TREASURY PRIME RATE

1992 1993
1 9 8 7 1 9 8 8 1 9 8 9 1 9 9 0 1 9 9 1 1 9 9 21 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1999 2000 JAN 6.50 6.00
JAN 5.78 6.99 9.05 7.92 6.64 4.16 3.50 3.54 7.05 5.09 5.61 5.24 4.51 6.12 FEB 6.50 6.00
FEB 5.96 6.64 9.25 8.11 6.27 4.29 3.39 3.87 6.70 4.94 5.53 5.31 4.70 6.22 MAR 6.50 6.00
MAR 6.03 6.71 9.57 8.35 6.40 4.63 3.33 4.32 6.43 5.34 5.80 5.39 4.78 6.22 APR 6.50 6.00
APR 6.50 7.01 9.36 8.40 6.24 4.30 3.24 4.82 6.27 5.54 5.99 5.38 4.69 6.15 MAY 6.50 6.00
MAY 7.00 7.40 8.98 8.32 6.13 4.19 3.36 5.31 6.00 5.64 5.87 5.44 4.85 6.33 JUN 6.50 6.00
JUL 6.00 6.00
JUN 6.80 7.49 8.44 8.10 6.36 4.17 3.54 5.27 5.84 5.81 5.69 5.41 5.10 6.17 AUG 6.00 6.00
JUL 6.68 7.75 7.89 7.94 6.31 3.60 3.47 5.48 5.59 5.85 5.54 5.36 5.03 6.08 SEP 6.00 6.00
AUG 7.03 8.17 8.18 7.78 5.78 3.47 3.44 5.56 5.75 5.85 5.56 5.21 5.20 6,18 OCT 6.00 6.00
SEP 7.67 8.09 8.22 7.76 5.57 3.18 3.36 5.76 5.62 5.83 5.52 4.71 5.25 6.13 NOV 6.00 6.00
OCT 7.59 8.11 7.99 7.55 5.33 3.30 3.39 6.11 5.59 5.55 5.46 4.12 5.43 6.01 DEC 6.00 6.00
NOV 6.96 8.48 7.77 7.31 4.89 3.68 3.58 6.54 5.43 5.42 5.46 4.53 5.55 6.09
1994 1995
DEC 7.17 8.99 7.72 7.05 4.38 3.71 3.61 7.14 5.31 5.47 5.53 4.52 5.84 5.60
JAN 6.00 8.50
THREE YEAR TREASURY FEB 6.00 9.00
MAR 6.25 9.00
1 9 8 7 1 9 8 8 1 9 8 9 1 9 9 0 1 9 9 11 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1999 2000 APR 6.75 9.00
MAY 7.25 9.00
JAN 6.41 7.87 9.20 8.13 7.38 5.40 4.39 4.48 7.66 5.20 6.16 5.38 4.61 6.49 JUN 7.25 9.00
FEB 6.56 7.38 9.32 8.39 7.08 5.72 4.10 4.83 7.25 5.14 6.03 5.43 4.90 6.65 JUL 7.25 8.75
MAR 6.58 7.50 9.61 8.63 7.35 6.18 3.95 5.40 6.89 5.79 6.38 5.57 5.11 6.53 AUG 7.75 8.75
APR 7.32 7.83 9.40 8.78 7.23 5.93 3.84 5.99 6.66 6.11 6.61 5.58 5.03 6.36 SEP 7.75 8.75
MAY 8.02 8.24 8.98 8.69 7.12 5.81 3.98 6.34 6.27 6.27 6.42 5.61 5.33 6.77 OCT 7.75 8.75
JUN 7.82 8.22 8.37 8.40 7.39 5.60 4.16 6.27 5.80 6.49 6.24 5.52 5.70 6.43 NOV 8.50 8.75
DEC 8.50 8.50
JUL 7.74 8.44 7.83 8.26 7.38 4.91 4.07 6.48 5.89 6.45 6.00 5.47 5.62 6.28
AUG 8.03 8.77 8.13 8.22 6.80 4.72 4.00 6.50 6.10 6.45 6.06 5.24 5.77 6.17 1996 1997
SEP 8.67 8.57 8.26 8.27 6.50 4.42 3.85 6.69 5.89 6.41 5.98 4.62 5.75 6.02 JAN 8.25 8.25
OCT 8.75 8.43 8.02 8.07 6.23 4.64 3.87 7.04 5.77 6.08 5.84 4.18 5.94 5.85 FEB 8.25 8.25
NOV 7.99 8.72 7.80 7.74 5.90 5.14 4.16 7.44 5.57 5.82 5.76 4.57 5.92 5.79 MAR 8.25 8.50
DEC 8.13 9.11 7.77 7.47 5.39 5.21 4.54 7.71 5.39 5.91 5.74 4.48 6.14 5.26 APR 8.25 8.50
MAY 8.25 8.50
FIVE YEAR TREASURY JUN 8.25 8.50
JUL 8.25 8.50
1 9 8 7 1 9 8 8 1 9 8 9 1 9 9 0 1 9 9 1 1 9 9 21 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1999 2000 AUG 8.25 8.50
JAN 6.64 8.18 9.15 8.12 7.70 6.24 4.93 5.09 7.76 5.36 6.33 5.42 4.60 6.58 SEP 8.25 8.50
FEB 6.79 7.71 9.27 8.42 7.47 6.58 4.53 5.40 7.37 5.38 6.20 5.49 4.91 6.68 OCT 8.25 8.50
MAR 6.79 7.83 9.51 8.65 7.77 6.95 4.40 5.94 7.05 5.97 6.54 5.61 5.14 6.50 NOV 8.25 8.50
DEC 8.25 8.50
APR 7.57 8.19 9.30 8.77 7.70 6.78 4.30 6.52 6.86 6.30 6.76 5.61 5.08 6.26
MAY 8.26 8.58 8.91 8.74 7.70 6.69 4.40 6.78 6.41 6.48 6.57 5.63 5.44 6.69 1998 1999
JUN 8.02 8.49 8.29 8.43 7.94 6.48 4.53 6.70 5.93 6.69 6.38 5.52 5.81 6.30 JAN 8.50 7.75
JUL 8.01 8.66 7.83 8.33 7.91 5.84 4.43 6.91 6.01 6.64 6.12 5.46 5.68 6.18 FEB 8.50 7.75
AUG 8.32 8.94 8.09 8.44 7.43 5.60 4.36 6.88 6.24 6.64 6.16 5.27 5.84 6.06 MAR 8.50 7.75
SEP 8.94 8.69 8.17 8.51 7.14 5.38 4.17 7.08 6.00 6.60 6.11 4.62 5.80 5.93 APR 8.50 7.75
MAY 8.50 7.75
OCT 9.08 8.51 7.97 8.33 6.87 5.60 4.18 7.40 5.86 6.27 5.93 4.18 6.03 5.78 JUN 8.50 7.75
NOV 8.35 8.79 7.81 8.02 6.62 6.04 4.50 7.72 5.69 5.97 5.80 4.54 5.97 5.70 JUL 8.50 8.00
DEC 8.45 9.09 7.75 7.73 6.19 6.08 5.15 7.78 5.51 6.07 5.77 4.45 6.19 5.17 AUG 8.50 8.25
SEP 8.25 8.25
11th District Cost of Funds OCT 8.00 8.25
NOV 7.75 8.50
1 9 8 7 1 9 8 8 1 9 8 9 1 9 9 0 1 9 9 1 1 9 9 2 1993 1994 1995 1996 1 9 9 7 1 9 9 8 1999 2000 DEC 7.75 8.50
JAN 7.40 7.62 8.13 8.37 7.86 6.00 4.36 3.71 4.75 5.03 4.82 4.99 4.61 4.90
FEB 7.45 7.65 8.35 8.40 7.85 5.80 4.33 3.69 4.93 4.98 4.76 4.97 4.56 4.97 2000 2001
MAR 7.31 7.51 8.42 8.26 7.65 5.61 4.25 3.63 5.01 4.87 4.78 4.92 4.52 5.00 JAN 8.50 9.00
APR 7.25 7.52 8.65 8.21 7.50 5.43 4.17 3.67 5.06 4.84 4.82 4.90 4.49 5,08 FEB 8.75 8.50
MAR 9.00
MAY 7.22 7.50 8.80 8.17 7.33 5.29 4.10 3.73 5.14 4.82 4.86 4.88 4.48 5.20 APR 9.00
JUN 7.27 7.62 8.92 8.09 7.16 5.26 4.05 3.80 5.18 4.81 4.85 4.88 4.50 5.36 MAY 9.50
JUL 7.28 7.59 8.84 8.11 7.00 5.07 4.00 3.86 5.14 4.82 4.89 4.91 4.50 5.46 JUN 9.50
AUG 7.28 7.66 8.76 8.08 6.85 4.87 4.00 3.95 5.13 4.84 4.90 4.90 4.56 5.51 JUL 9.50
SEP 7.39 7.85 8.81 8.09 6.71 4.81 3.88 4.04 5.11 4.83 4.94 4.88 4.61 5.55 AUG 9.50
OCT 7.44 7.83 8.64 8.05 6.57 4.60 3.82 4.19 5.12 4.84 4.96 4.76 4.67 5.59 SEP 9.50
OCT 9.50
NOV 7.56 7.91 8.60 8.04 6.41 4.51 3.82 4.37 5.12 4.84 4.95 4.69 4.77 5.61 NOV 9.50
DEC 7.65 8.02 8.48 7.96 6.25 4.43 3.88 4.59 5.06 4.84 4.96 4.66 4.85 5.62 DEC 9.50
Table 3-8
59
Chapter 3
We will first discuss these complexities before introducing the many types of adjustables which are
available as mortgage instruments in today's marketplace.
Determining adjustable rates—the index

Adjustables must contain mechanisms to determine future rate changes. Every adjustable rate mort-
gage has an index which determines the rate of the mortgage in future years.
An index is an indicator or reference of particular interest rates which are being measured by that
indicator. As this indicator or measure of rate increases, so will the rate on the adjustable mortgage in the
future. One could devise an index for any interest rate. For example:
If we wanted to use the prime lending rates of major banks:
Bank A—Prime is presently 8.00%
Bank B—Prime is presently 9.00%
Bank C—Prime is presently 8.50%
Our index would simply create an average:
8.00% + 9.00% + 8.50% = 25.5%
25.5% ÷ 3 = 8.50%
If we took this measurement over time (say, every six months) we could track our Prime Lending Rate
Index over the years:
January, 1990 8.5% July, 1990 8.0%
January, 1991 7.5% July, 1991 7.5%
January, 1992 9.0% July, 1992 8.5%
An adjustable rate mortgage based upon this index might be called a prime rate adjustable.
There seems to be no limit upon the different type of indices which may rule the future rate changes of
adjustable rate mortgages. The following presents an introduction to many of the more common indices.
Common adjustable rate indices

• Prime Lending Rate. The prime lending rate is the lowest rate charged to the best customers of the
bank for short term lending. A bank may lend using their own prime rate as the index upon which
future adjustments of the rate will be based. Or there are some major banks which will lend based
upon an average of prime rates for major banks. Since each bank determines its own prime rate it
would seem that the average would provide more protection for the borrower. However, typically the
major banks move their prime lending rates in tandem and there is little variation in this measure
within the industry.
• Treasury Constant Maturity Indices. Also know as the “T” Bill and TCM indices, these indices are
actually the most common offered today for first trust mortgages. Treasury Securities are issued by the
Federal Government to raise capital. These securities are offered in various denominations or lengths:
3 month, 6 month, 1 year, 2 year,....all the way up to 30 year. Short term securities (for example, 3
month) are known as "T”Bills. Medium term securities (for example, 3 year) are known as “T”
Notes. Long term securities (30 year) are known as "T" Bonds.
60
Types of Mortgages
A particular TCM index actually averages all outstanding securities with the term of the index left
until maturity. For example, a 6 month index would be an average of all outstanding treasury securities
with six months left in their term. This is what the term averaged for a constant maturity denotes.
Typically, a one year adjustable rate mortgage will carry a 1 Yr TCM, or 1 Yr “T” Bill index. This
matches the length of the adjustment term of the mortgage to the TCM index.
• 11th District Cost of Funds Index. The State of California has long been the home of very large
Savings and Loan Institutions. These institutions created adjustable rate mortgage instruments which
were tailored to the booming California real estate market during the 1980s. This market was
characterized by rapidly escalating prices and an extreme amount of mobility among purchasers. The
borrowers in California and other escalating markets were not interested in long term security. They
were interested in qualifying for the largest mortgage possible so that they could take advantage of
rising prices.
The 11th District refers to the 11th Federal Home Loan Bank District which includes the State of
California. The Cost of Funds index actually is a measure of the expense these institutions incur in
order to attract funds, or deposits. It makes sense that they would try to match the interest they charge
on mortgages to their actual cost of doing business. These adjustable rate mortgages became quite
popular in the 1980s and were offered by many institutions outside of the 11th District.
Another version of the Cost of Funds index would be the Monthly Median Cost of Funds of all FSLIC-
insured institutions. Though it would seem that a national index of the cost of funds for all savings
institutions would become a standard, this index has not been utilized as often as the 11th District
Index in the formulation of mortgage products.
• Libor Index. The Libor Index is a relative newcomer to the mortgage scene but may be a very important
in the development of foreign sources of funds for mortgages in the future. Libor is short for London
Interbank Offered Rates. It is the average rate of interest that five major London banks are willing to
pay each other for US dollar deposits for various terms. Fannie Mae and Freddie Mac have actually
developed indices of these rates and these are often used as the index for Libor based adjustable rate
mortgages. It makes sense that if we are to attract foreign dollars to finance our mortgage markets we
would have to integrate the measurements employed by overseas financial institutions.
• The Consumer Price Index. Since the inflation rate is the major determinant of the future of interest
rates, it is not surprising that there has been some interest in making the Consumer Price Index an
index for adjustable rate mortgages. The Consumer Price Index is the government's main gauge for
measuring the current inflation rate. In the past, FHA authorized a pilot program for PLAMs, or Price
Level Adjustment Mortgages. The PLAM would have adjustments partially based upon changes in
the inflation rate and partially based upon a more common index such as the 1 year TCM. Thus far,
inflation based adjustables have not had an impact on the adjustable rate mortgage market.
Determining adjustable rates—the margin

While the adjustable rate mortgage's rate movements are determined by the index, each adjustable
also has a margin to determine exactly where the rate will be fixed after each rate change. It makes sense
that financial institutions would not lend money exactly at the yield of Treasury Securities, because they
could receive that yield from the Federal Government. In the case of the Cost of Funds Index, the Savings
Institutions cannot afford to lend money out at the same rate they are paying depositors. Therefore, you
can think of the margin as a profit margin over the index for an adjustable rate mortgage.
61
Chapter 3
What are common margins for adjustable rate mortgages? The most common adjustable rate mort-
gage for first trust mortgages is a 1 year adjustable, which has a rate change every year. The most com-
mon index for the 1 year adjustable is the 1 Year "T”Bill or TCM index. The most common margin used
with this mortgage instrument is 2.75% over the value of the index. Adjustable rate mortgage margins will
typically range from 2.00% for an FHA adjustable to 3.00% for
mortgages on properties that are not owner-occupied (investor).
Once we know the index and the margin, the formula is simple: Index and Margin—
the index plus the margin equals the new rate each time the ARM Determining the Rate of an
is adjusted. However, since most indices can have any value (for ARM
example, the one year TCM can be at 4.05) and mortgages are At each rate change, the new rate is
determined by the index plus the margin.
commonly limited to “eighth percent increments” (4.000%, For example:
4.125%, or 4.250%), there is some question as to how the rate is
Index = 5.00%
actually figured at adjustment. There are actually three possibili- + Margin = 2.75%
ties: New rate = 7.75%
1. Round the rate to the nearest one-eighth of a percent; Over time, the rates might change as
follows:
2. Round the rate up to the next one-eighth of a percent;
3. Round the rate down to the next one eighth of a percent. Margin
10
Index
Let's take an example to illustrate all three: 9
8
Index One Year TCM
7
Value at Adjustment 3.95
6
Margin 2.75 Rate
5
Index plus Margin 6.70 4
1. Nearest one-eighth of a percent 6.75% 3
2. Round up 6.75% 2
3. Round down 6.625% 1
0
The most common form of adjustment calculation is the first 1 2 3 4 5 6 7 8 9 10
example, rounding to the nearest one-eighth of one percent.
Year
Determining adjustable rates—the starting rate

The initial rate for an adjustable will be chosen from one of two options:
• Fully indexed accrual rate (FIAR). The fully indexed accrual rate is simply the present value of the
index plus the margin. Therefore, if the index is presently at 4.00% and the margin is set at 2.75%, the
FIAR will be 6.75%.
• Teaser rate. The FIAR would seem to be the logical starting rate for an adjustable rate mortgage.
Unfortunately, the FIAR makes starting rates for adjustables too high to be attractive to consumers.
The fully indexed rate puts the starting rate of an adjustable too close to the starting rates of fixed rate
mortgages. Without a spread, or a guaranteed lower rate for a certain period of time, consumers
generally will not chose adjustable rate mortgages over fixed rate alternatives. Adjustables are therefore
marketed with what are called teaser rates, or starting rates which are below market or the FIAR.
62
Types of Mortgages
In the previous example with a FIAR at 6.75%, the starting rate of the adjustable might be 4.50%. Of
course, these teaser rates more or less guarantee future increases in rates for the adjustable, even if market
rates (the index values) stay the same in the future.
Determining adjustable rates—time periods

There are literally hundreds of adjustable rate mortgages on the market today and the most significant
variable among these mortgages is the adjustment period. The adjust-
ment period is simply the frequency of the rate changes.
The most popular adjustable rate mortgage is the 1 Year ARM which Adjustables are Named
has rate changes annually. There are adjustables which change monthly, After Their Adjustment
every six months, every three years and even once in ten years. Adjustables Periods:
which have more frequent rate changes will carry lower starting rates One Year ARM—
rate changes every year
than long term adjustables which have rate changes only every three or
more years. To balance out these lower starting rates, the short term Three Year ARM—
rate changes every 3 years
adjustables will have a greater risk of rate increases because of the more
frequent rate changes.
It is also possible that the period of rate change may not be fixed on an adjustable. For example, a
prime plus home equity second trust may have a rate change every time the prime rate changes. This
means that the rate may not change for two years or it may change every month, depending upon how
often the banks change their prime lending rate.
The period of rate change on an adjustable may also change during the term of the mortgage. The
most common example of these are the 3/1, 5/1, 7/1, and 10/1 ARMs. These adjustables have fixed rates
for a certain period of time and then change into one year adjustables after that period. For example, a 3/
1 ARM will have a rate which is fixed for three years and then adjusts annually every year thereafter. This
may be compared with a 3/3 ARM which has rate changes every three years over the term of the
mortgage. A 3/3 ARM is also known as a true three year adjustable.
Determining adjustable rates—protection against unlimited rate changes

The risk would be unpalatable for any borrower or mortgage purchaser if an adjustable rate mortgage's
interest rate could increase without limits with each adjustment. For this reason, the vast majority of ARMs
marketed today offer limits on future rate adjustments. These limits are called caps. There are two types of
rate caps usually offered:
1. Adjustment period caps limit each rate change. A one year adjustable would have an annual cap and
a three year adjustable would have a cap every three years. By far the most common cap is 2.0%
during each rate change with some notable exceptions:
• A six month adjustable is likely to have a 1.0% cap each six months, which is the equivalent of
2.0% each year.
• Some 3/1, 5/1, and 7/1 adjustables will allow maximum (life cap) adjustments after the fixed rate
term expires and before the annual changes begin. Once the annual changes are in effect, there is
typically a 2.0% annual cap in place.
63
Chapter 3
For example, a 3/1 ARM which starts at 7.0% may have a rate fixed at 7.0% for three years. If
there is a life cap of 6.0%, the adjustable can move to 13.0% after the third year. Every year
thereafter, there is an annual cap on rate adjustments of 2.0%.
• Some one year adjustables have a 1.0% annual adjustment cap, including ARMs offered by
FHA. The added protection of a lower adjustment cap will normally be accompanied by a higher
starting rate on that particular adjustable as opposed to one year adjustables with 2% adjustment
caps.
It is important to note that adjustment period caps limit increases and decreases each adjustment term.
A 2.0% annual cap on a one year adjustable dictates that the adjustable cannot decrease more than
2.0% in any one year as well as limiting the increase to 2.0%.
2. Life caps give rate protection over the term of the mortgage. If a one year adjustable has a starting rate
of 5.0% and a life cap of 6.0%, then the interest rate can never exceed 11.0% at any time during the
mortgage term. Six percent is the most common life cap among adjustables though there are once
again some common exceptions, including the FHA one year adjustables which have a 5.0% life cap.
Determining adjustable rates—the floor

Many who opt for adjustable rate mortgages assume that the starting rate may go down from the initial
teaser rate of the adjustable. This is typically not the case. The starting,
or teaser rate of the adjustable may actually also be the floor of the ad-
justable. A floor is the lowest rate which an adjustable rate mortgage can Adjustable Rate
achieve. Because the starting rates of most adjustables are below mar- Floor Example
ket, the concept of a floor is typically not very disturbing. Using the At each rate change, the new
example in the margin, we can see that there is a teaser rate on this loan rate is determined by the
index plus the margin. For
because the starting rate is 2.25% below the Fully Indexed Accrual Rate, example:
or FIAR. Since the floor is also the starting rate, or 4.50%, the question Index = 4.00%
is-- Margin = 2.75%
FIAR = 6.75%
“How low would the index have to go in order for the adjustable to
Start rate = 4.50%
drop below that 4.50% starting rate?”
Floor = 4.50%
As shown in the example, the index would have to be less than 1.75% — Margin = 2.75%
for the floor to take effect, which is very unlikely (see table 3-8 on page Index at floor
= 1.75%
59). Also note that the index would have to drop to 1.75% in order for
the rate not to adjust upward at the next adjustment period. This is why
teaser rates virtually assure rate increases in future years for ARMs.
Which is more important—the margin or the caps?

Many borrowers tend to think that adjustables will increase as fast as the caps will allow them to
increase. The reasons for this are two fold:
1. Teaser rates have made future increases much more likely. As our discussion of adjustable rate
mortgage floors has illustrated, most ARMs start below market and therefore make increases in
the early years very likely. When the mortgage rate is increasing, it is more likely that the caps will
be a factor.
64
Types of Mortgages
2. We tend to think of the worst case scenario when we think of ARM products. The worst case
scenario simply means that the adjustable will increase as fast as it is allowed to increase—the
only constraint being the caps. In this scenario there is no involvement by the margin-plus-index
rate setting mechanism.
In a real world scenario, sometimes the caps will constrain future movements of the adjustable rate
mortgage and at other times the index and the margin will determine the rate. We can think of the index
and the margin as telling us where the rate should go, with the caps telling us how far we can go. Think
of the caps as a fence around the playground constraining how far a child can wander. The adjustment
period cap is an inner fence which moves with the child and the life cap is an outer fence which remains
in place forever. Because of teaser rates, the early years will usually test the involvement of caps. After a
few adjustments, the margin and index will become more important.
Let us take an example:
Type One year ARM
Index One year TCM
Margin 2.75 One Year ARM
Starting Rate 4.50 example
Index at Start 4.00 Rate
14 Life Cap
FIAR 6.75
Index +Margin
Annual Cap 2.00
Life Cap 6.00 12
Index History:
Year Rate 10
1 4.25
2 5.00
3 5.50 8
4 9.00
Rate
5 9.50
6
6 7.00
The chart in the margin shows the resulting rates over
the first years of the loan. Let's look at how the rates are 4
determined during the first six years.
Year 1. The first year's rate is the start rate of 2
4.25%. The index and margin do not
directly affect this rate.
0
Year 2. The index plus the margin equal 7.75%, 1 2 3 4 5 6
which is more than 2.0% above the starting
Year
rate of 4.50%. Therefore, the adjustment
cap of 2.0% is the limit. The new rate is
6.25%.
Year 3. Index plus margin equals 8.25%, which is the same as the 2.0% allowable adjustment
cap. The new rate is 8.25%.
65
Chapter 3
Year 4. Index plus margin equals 11.75%, which is more than 2.0% above the previous year's
rate. Therefore, the adjustment cap of 2.0% will rule. The new rate is 10.25%.
Year 5. Index plus margin is 12.25%. Last year's rate plus 2.0% is 12.25%. However, both of
these rates are above the life cap. The rate stays at 10.25%, the life cap.
Year 6. Index plus margin has dropped to 9.75%. This is below the life caps and within the annual
cap limits (which are up or down), so the ARM rate drops to 9.75%.
The worst case scenario One year ARM

When a mortgage applicant opts for an adjustable rate mortgage the Starting Rate 5.00%
applicant often asks, “What is the worst that can happen to me?” This Caps
is a reasonable question to ask. If the adjustable rate mortgage goes up as Annual 2.00%
Life 6.00%
fast as it can—yet is still palatable to the consumer—then that consumer
is a good candidate for this type of mortgage. We call this the worst case Worst Case:
scenario for the adjustable. In the margin you will find illustrations of a Year Rate
1 5.00%
few worst case scenarios for particular ARM products. 2 7.00%
It can be seen from these examples that the worst case scenario is not 3 9.00%
4 11.00%
affected by the margin or the index. The only factors are the starting rate 5-30 11.00%
and caps, as the ARM will increase as fast as the caps will allow. It does
not matter if the index increases 2.0% each year or goes up to 50.0%
Why would someone opt for an adjustable knowing that the worst Three Year ARM
case could happen? There are many reasons for this: Starting Rate 7.00%
• Perhaps the applicant will only own the home for a few years. Caps
3-Year 2.00%
• Perhaps the applicant's income will be increasing dramatically in Life 6.00%
the future. Worst Case:
• Perhaps the applicant cannot qualify for the higher payments of a Year Rate
fixed rate mortgage. 1-3 7.00%
4-6 9.00%
7-9 11.00%
Potential negative amortization 9-30 13.00%
Thus far, all adjustables we have examined are examples of posi-
tively amortized mortgages. That is, every payment which is applied to
the mortgage actually decreases the amount of principal which is outstanding until the mortgage is com-
pletely paid off at the end of the mortgage term. Most adjustable rate mortgages are fully amortized 30
year term adjustables. Earlier in our discussion of graduated payment mortgages, we introduced the
concept of scheduled negative amortization. In the case of scheduled negative, the mortgage's principal
balance actually increased during the early term of the mortgage and the increasing payments caused
accelerated prepayments later in the mortgage term after the period of scheduled negative. The term
scheduled refers to the fact that any increase in principal balance is known from the beginning of the
mortgage term.
Adjustable rate mortgages can also allow for negative amortization. In the case of an adjustable the
future rate of the mortgage is not known and therefore the amount of negative amortization in the future
is also not known at the mortgage's inception. This is why we say that the adjustable has only a potential
for negative amortization.
66
Types of Mortgages
The feature of negative amortization in an adjustable rate mortgage is Potential Negative

brought into play with the introduction of a payment cap. Quite simply, a Amortization
payment cap will limit the amount that the payment can increase—usually Type 1 year ARM
each year. In a typical ARM, the payments are adjusted to fully amortize the Term 30 year
Amount $100,000
mortgage each time that there is a rate adjustment. In the case of an adjust-
Start Rate 5.00%
able with potential negative, one can limit payment increases, perhaps to less Caps
than is required by the new interest rate to fully amortize the mortgage. The Annual 2.00%
example on this page illustrates the concept of a payment cap and negative Life 6.00%
Payment35 7.50%
amortization.
The first year payment is the same as with any other adjustable rate mort- Year 1:
Rate 5.00%
gage—it is at the start rate and does not involve any negative amortization.
Payment $536.82
In example 2a, the interest rate caps would allow the payment to rise to Neg. Am. $0.00
$665.30 each month, but the payment cap is $88.22 less, or $577.08. There- per mo.
fore, $88.22 will be added to the loan balance each month, increasing the Year 2a:
Rate 7.00%
principal amount of the loan $1,058.64 at the end of year one. In example
Int. Cap. $665.30
2b, the payment cap is actually higher than the required payment. Therefore, Pmt. Cap. $577.08
the required payment of $567.79 will be made and the loan will be fully Payment $577.08
amortized in the second year. This is why we say that the loan has potential
Neg. Am. $88.22
negative amortization. We cannot predict whether the loan will have nega- per mo.
tive amortization because we do not know whether future rate increases will Year 2b:
make the payments rise faster than the payment cap. After analyzing this Rate 5.50%
example, we should take into consideration the following: Int. Cap $567.79
Pmt. Cap $577.08
• There is usually a limit by which the loan balance can increase over the Payment $567.79
life of the loan. This limit typically ranges from 110% to 125% of the Neg. Am. $0.00
per mo.
loan balance. For example, if the original mortgage balance was $100,000
and the limit of increase was 110%, then the loan balance can never exceed $110,000.
• Adjustable rate mortgages with potential negative amortization will typically require higher down
payments than other adjustables because of the potential increase in mortgage balance.
• It should be noted that the payment cap is an option, not a requirement. Because there are no prepayment
penalties associated with these mortgage instruments, one can always opt to make the full required
payment in any one year and the mortgage will not be subject to increase.
• When one compares adjustable rate mortgages with negative features to others which do not have
these features, one should simply remove the payment cap option before making the comparison of
start rates, indices, margins and interest rate caps. Now how do the loans compare?
Conversion features
Many adjustable rate mortgages have conversion features, which is the ability to convert the mortgage
from an adjustable to a fixed rate at some juncture during the loan term. Similar to negative amortization,
a conversion feature is an option which does not have to be utilized. When shopping for a conversion
feature on a adjustable rate mortgage, one should discern:
35
Note that the payment cap is 7.5% of the payment, not the interest rate. For example, a $1,000 monthly payment with a 7.5% payment cap
would have a cap of $75 for the next payment increase. This 7.5% figure is typical for ARMs with potential negative amortization and is
roughly the amount of payment increase which would take place if the interest rate increases by 1%.
67
Chapter 3
• What is the front end cost of the conversion feature? Unlike potential negative amortization, the major
components of the mortgage are not likely to change because of this feature. The caps, margin, and
index are all likely to stay the same, but many adjustables with conversion options may cost more than
comparable instruments without these options, usually in terms of a higher starting rate and/or points.
One must compare these costs to the potential benefit of a conversion option to determine if the option
of converting to a fixed rate makes sense in terms of the extra cost.
• What is the back end cost of converting? Though most conversions do not require the typical costs of
refinancing, there is usually a flat fee at the time of conversion. This fee can range from $250 to
$1,000. Because you do not have to utilize the option to convert to a fixed rate, you will not incur this
fee unless you actually utilize the conversion feature. Since the back end fee is not certain, it may not
be as significant as a front end cost which definitely will be incurred at the inception of the mortgage.
• What is the window of conversion? Most convertible adjustable rate mortgages do not allow one to
convert at any time. Most allow conversion at the time of rate adjustment (annually on a one year
adjustable) and may also limit the years in which conversion may be effected. For example, a typical
conversion feature may allow conversion on the second through fifth anniversary dates. In this case
the term anniversary date is utilized to describe the first day of the month each full year after the
mortgage inception.
• What is the fixed rate of conversion? The mortgage will convert to the market for fixed rates at the
time of conversion. This is likely to be higher than the adjustable's interest rate at that particular
juncture. How is the rate of conversion figured? There is actually an index and margin within the
conversion feature which will be specified in the initial program disclosure at loan application. Usually
the index will be one which measures conventional fixed rates purchased by Fannie Mae or Freddie
Mac. To this index is typically added a margin of 0.625% on conforming loan limits and 0.875% on
jumbo loan limits. There may be no cap on the conversion. This means that if market fixed rates are
20%, then the loan will convert at that rate.
• Can the lender keep you from converting? The answer is yes! If the mortgage payment history shows
late payments or the loan is not current at the time of conversion, the note usually provides for removal
of the option to convert. There may be other restrictions, so it pays to read loan disclosures carefully.
• Is converting better than refinancing? Though refinancing may actually cost more than converting,
one should check the market for available interest rates through refinancing before one converts. The
minimal amount of costs for conversion and the associated interest rate should be compared to the
heavier cost of refinancing and interest rates associated with refinancing.
Reverse Mortgages
The formal name for reverse mortgages is The Home Equity Conversion Mortgage, or HECM. A
reverse mortgage lends on the basis of a homeowner's equity in a home. The homeowner does not need
monthly income to qualify for the mortgage program nor do they make payments on the loan until the
home is sold, the borrower becomes deceased, or permanently moves away.
If one were to borrow $50,000 under a traditional mortgage program, the homeowner could need an
annual income of $20,000 or more. Over seventy percent of seniors own their home outright, but many
68
Types of Mortgages
do not have the income stream to support themselves. This presents a catch 22: sitting on a pot of gold
which they need desperately but cannot touch. A reverse mortgage makes this pot of gold achievable.
Selling the home is an option, but this can mean relocating from a long term residence, which is traumatic
for many seniors.
Reverse mortgages present three major opportunities for homeowners:
• They can receive a lump sum of cash. This is identical to receiving cash from a first or second
mortgage refinance—except that there are no monthly payments required.
• They can opt for an open line of credit. Home equity lines of credit (HELOCs) are very popular
in America today. Once again, the major difference with regard to reverse mortgages is that a
monthly payment is not required.
• They can opt for a monthly income. This monthly payment from the lender would continue until
the borrower become deceased, the home is sold or the homeowner permanently moves away.
Combinations of the three are also possible. For example, under the HUD sponsored program the
homeowner may opt for a lump sum of cash and a monthly payment.
Generally, there are very few lenders which participate in the program as compared to traditional
mortgages. In the past, there has also been a shortage of counselors who are responsible to guide seniors
through the process. When there is less competition there is the potential for higher costs and hidden
charges. Some of the potential for such abuse is discussed in Ken Sholen's book, Your New Retirement
Nest Egg: A Consumer Guide to the New Reverse Mortgages (NCHEC Press).
The costs associated with setting up a reverse mortgage can make the loan a very expensive option if
a small amount of money is utilized and/or the homeowner uses the money for a very short period of time.
The issue of disclosing costs has been debated for some time and is partially solved by a law which
requires lenders to provide a Truth-in-Lending disclosure, or TALOC (Total Annual Loan Cost). Higher
overall borrowing costs for small loan amounts or a shorter term is germane to all lending but is especially
complex when dealing with the added complexity of a reverse mortgage.
There are strict limitations on the amount of the home's equity that can be utilized. For example, FHA
allows a cash out refinance of up to 85% of the home's value. Under HUD's reverse program the home-
owner may be able to tap only 40% or less of the value—depending upon factors which include the
expected life of the homeowner. There is no free lunch—if no mortgage payments are being made the
lender needs a extra margin of security. FHA also requires HELM counseling
With the graying of America already underway, reverse mortgages promise to continue growing in
popularity. In 1995, Fannie Mae released its reverse mortgage program called the Home Keeper. This
action promised to help make reverse mortgages available to more homeowners across the nation. To be
eligible for the Home Keeper one must be at least 62 years of age and condominiums and cooperatives are
not eligible. The program requires consumer education sessions on reverse mortgages and the program
includes three payment options. The mortgages are priced as adjustable rate loans. Fannie Mae also
purchases reverse mortgages insured by FHA and has become the nation's largest investor in reverse
mortgages with the addition of their Home Keeper product.
69
Qualifying For a Mortgage: Ratios and Residuals
4
Qualifying For a Mortgage: Ratios
and Residuals Mortgage math
Residual Ratios
There are a multitude of variables which factor into the
consideration of one's qualifications for a mortgage loan: • VA mortgages • All conventional
mortgages
credit, amount of down payment, cash reserves, job stability, • Some jumbo • FHA mortgages
the property, etc. Many of these factors can move into the mortgages • Partial standard for
realm of subjectivity. Overriding the whole process are math- VA mortgages
ematical calculations which actually dictate the major portion
of the decision making process: ratios and residuals. All of the other factors are actually minimum stan-
dards: for example minimum cash reserves. In other words, if the mathematics meet program standards,
as long as the applicant meets other minimum standards the mortgage will be approved.
If the ratios do not meet standards, there must be other overriding considerations, for example, a very
large down payment. These additional overriding considerations are called compensating factors. A com-
pensating factor is actually a large positive which outweighs a major negative factor in the application.
In this chapter we will deal with the calculation of ratios and residuals, which are the mathematical
standards of qualification for almost all mortgages.
The ratio method of qualification

The philosophy of the ratio method of qualification is simple: a certain Housing
percentage of income is allowed to be allotted to housing expense and other
monthly liabilities, or debts. In times past, almost everyone who has rented an
apartment has been informed by the leasing agent that one qualifies for a rent
payment of one weekly paycheck out of the month. The leasing agent was
crudely calculating a ratio of 25%: one quarter of the monthly income can be Housing
attributed to the housing expense.
Debts
In calculating mortgage ratios, we use the gross monthly income, or GMI,
which represents the income before all deductions are taken out.
Simply put:
$60,000 annual salary equals $5,000 gross monthly income ($60,000 divided by 12)
It is the gross monthly income that serves as the denominator for the calculation of all mortgage ratio
calculations.
71
Chapter 4
There are actually two ratios which are calculated with the gross The monthly mortgage
monthly income as the denominator for most mortgage programs: payment
• Housing, first, front, or inside ratio $95,000 Conventional
mortgage
• Debt, second, back, or outside ratio $100,000 Sales price
$8.5% Interest rate
XYZ $1,800 In annual real estate
gross monthly income (GMI) property taxes
$240 In annual homeowners
insurance
$30 In monthly
homeowners
The housing ratio association dues
The numerator of the housing ratio will be the monthly mortgage PI = $730.47
T = $150.00
payment and any association dues required if the property is located in a
I = $20.00 (Homeowners
condominium or planned unit development project. Let us review the Insurance)
components of a monthly mortgage payment: $38.79 (Mortgage
Insurance)
The monthly mortgage payment (PITI + HOA) HOA = $30.00
• PI- Monthly principal and interest payment

• T- Monthly real estate property taxes Maximum acceptable housing
• I- Monthly insurance payments: ratios
• Monthly homeowners (and flood) insurance for all • 25% for some adjustable rate
programs
properties except condominiums • 28% for conforming
• Monthly mortgage insurance for all FHA mortgages and • 29% for FHA
conventional mortgages with less than a 20% down • 33% to 38% for low-to-moderate
payment income programs
• 33% for some jumbo and conforming
• HOA- Monthly condominium or homeowners association programs with minimum 10% down
dues (and any special assessments) payment
Now that we have the ability to calculate the numerator and the denominator of the housing ratio, we
can calculate the ratio.
In the example to the right, we say that the applicant's housing
ratio is 19.39. The next question is, is that ratio acceptable? Unless
there is another very negative factor, in most cases the applicant $969.26
would be considered very well qualified. = 19.39%
$5,000
It should be noted that the calculation of housing ratios may
be adjusted at times in the case of the purchase or refinance of a
property located within a condominium. The monthly condominium association fees commonly include
part or all of the utilities of the unit. If one were purchasing a single family home, we would not include
utilities in the housing ratio. If we included the total condominium fee in the housing ratio, there would be
utility expense included in the calculation. In the example on the following page, we would actually
reduce the amount of the fee by the percentage of the fee which is dedicated to utilities.
72
The debt ratio Reducing a condo fee

The debt ratio is also known as the back, outside, or second ratio. PITI ......................................... $1,000
This ratio calculation adds monthly liabilities to the housing expense Monthly condo fee ..................... $250
in order to calculate the total monthly indebtedness of the applicant. PITI + condo fee ..................... $1,250
These debts would be monthly liabilities, not normal living expenses: Monthly income ...................... $3,000
Housing ratio ............................ 41.66
• Monthly expenses for medical, life and auto insurance are not Condo fee .................................. $250
considered liabilities included in the debt ratio; Monthly association budget . $10,000
Utilities portion of budget36 ......... $5,000
• Installment loans and the monthly payments on credit cards are Percentage ................................. 50%
considered liabilities included in the debt ratio. In each of these Condo fee after reduction .......... $125
cases, the applicant is paying on a debt. PITI + reduced fee .................. $1,125
New housing ratio ..................... 37.50
The one monthly expense which can sometimes fall into the debt
column is child care. Generally, child care is not counted as a monthly
debt for conventional mortgages (this may vary for different programs). Rental negative
Child care is likely to be counted as a debt under VA qualification calculations. Monthly income: $1,000
Vacancy factor: (-) 25%
Monthly child support, separate maintenance, or alimony pursuant to a legal Net income: $750
separation agreement and/or divorce decree would be considered a monthly debt Monthly PITI: (-) $800
in all qualification calculations. Rental negative: ($50)
(to be included as a debt)
One type of monthly debt which can sometimes become part of the income
calculation is rental negative on a rental property owned by the applicant. To
calculate the rental negative, one would take the income on the rental property from the rental lease and
subtract the monthly mortgage payment including taxes, insurance and any homeowners association fees.
In most cases, the rental income would be reduced
by 25%, which is referred to a vacancy and/or PITI + HOA + Debts
= Debt Ratio
maintenance factor. If the rental negative became Gross Monthly Income
a positive, the income would be added to the gross
monthly income. Most lenders will consider tak-
$938.26 + 30.00 + $500
ing the rental negative (or income) directly from = 29.38%
$5,000
the Schedule E of the applicant's tax returns.
The debt ratio calculation Maximum acceptable debt ratios

Monthly Debt Breakdown: • 33% for some adjustable rate mortgages with 5% down
payment
$300 Monthly Car Payment • 36% for conforming mortgage programs
• 38% to 40% for low to moderate income programs and
$100 Personal Loan many jumbo mortgages with minimum 10% down payment
$100 Monthly Credit Card Payments • 41% for FHA and VA
Pre-qualification using ratios

Thus far we have simply been attempting to answer the question:
Does the applicant qualify for the proposed mortgage payment?
36
The utilities portion of the budget might as a loose interpretation include garbage collection, water, electricity, gas or any other
expense that a single family homeowner would have to pay out of pocket but we would not normally include in the housing expense
in our calculation of the housing ratio.
73
Chapter 4
This question assumes that the house, mort- Housing and debt ratios
gage amount and interest rate are known. Sup- Together we express common housing and debt ratios as follows:
pose these become unknown variables? Sup- • 25/33 for some adjustable rate mortgages with 5% down
payment
pose someone wants to know how large a
• 28/33 for some temporary buydowns
mortgage or home purchase for which they • 28/36 for conforming mortgage programs
qualify—before the home or loan program is • 33/38 for low to moderate income programs and many jumbo
identified? This is typically the process one programs with minimum 10% down payment
would follow in a visit to a real estate office— • 38/38 for FHLMC (low-to-mod)
• 29/41 for FHA mortgages
the process of pre-qualification. Pre-qualifica-
• 41 debt ratio only for VA mortgages
tion refers to the process of qualifying for a
hypothetical purchase or refinance transaction
before the transaction actually takes place. It is the answer to the questions:
How large a mortgage will I qualify for? and How large a house can I afford?
The mathematical process of pre-qualification actually involves working through the ratio calcula-
tions backwards. We know the income level, but we want to determine the maximum mortgage payment
and maximum mortgage amount for which the potential borrower qualifies.
Here are the ratios:
Now let's work backwards:
45 Back
Front
40
Housing Ratio: PITI + HOA
GMI 35
30
Debt Ratio: PITI + HOA + Debt
GMI 25
5% Conf. FHA Low/ VA
down Mod
Housing Ratio: GMI x 28% = PITI + HOA & Jumbo
Debt Ratio: GMI x 36% = PITI + HOA + Debts
Explanation: We are taking the gross monthly income of the applicant and multiplying by the
maximum housing and debt ratios (in this case 28/36). This yields the maximum mortgage payment and
the maximum mortgage payment with debts. Let us take an example:
Income: $5,000 Monthly
Debts: $500 Monthly
How large a mortgage payment will the above scenario support?
Housing Ratio: $5,000 x 28% = $1,400 = Maximum PITI + HOA
Debt Ratio: $5,000 x 36% = $1,800 - $500* = $1,300 = Maximum PITI + HOA
*Since the monthly debts are $500, we subtract $500 from $1,800 to arrive at the maximum
mortgage payment as dictated by the second, or debt, ratio. The maximum mortgage payment is
actually the lower of these two figures: in this case $1,300. If we used the $1,400 figure, the
second ratio would be too high:
$1,400 + $500
Debt Ratio = = 38.00% (exceeds 36%)
$5,000
74
The maximum mortgage payment by itself does not yield Interest Rate Factors
information which is very useful. What most potential home pur- Monthly P&I Payment per
$1,000 of Loan Amount
chasers want to know is:
Mortgage Term
How large a mortgage can I qualify for? Intere
Interest 30 20 15
st
Rate Year Year Year
We need to convert the maximum mortgage payment to a Rate
maximum mortgage amount. Of course, there are some very 4.0% 4.77 6.06 7.40
important variables: 4.5% 5.07 6.33 7.65
5.0% 5.37 6.60 7.91
• What is the interest rate of the mortgage?
5.5% 5.68 6.88 8.17
• What is the term of the mortgage? 6.0% 6.00 7.16 8.44
• What are the monthly taxes, insurance, and homeowners 6.5% 6.32 7.46 8.71
association dues? 7.0% 6.65 7.75 8.99
7.5% 6.99 8.06 9.27
Here are the assumptions: 8.0% 7.34 8.36 9.56
• A market rate of interest for a fixed rate, which is the most 8.5% 7.69 8.68 9.85
common mortgage (In this case we will use 8.0%). 9.0% 8.05 9.00 10.14
9.5% 8.41 9.32 10.44
• Thirty year amortization because this will yield the largest
10.0% 8.78 9.65 10.75
mortgage and is the most common mortgage choice.
10.5% 9.15 9.98 11.05
• Taxes, insurance and HOA dues represent 20% of the total 11.0% 9.52 10.32 11.37
mortgage payment. 11.5% 9.90 10.66 11.68
Calculation Example: 12.0% 10.29 11.01 12.00
12.5% 10.67 11.36 12.33
1. Maximum mortgage payment: $1,300 13.0% 11.06 11.72 12.65
2. Maximum mortgage payment minus taxes, insurance, and 13.5% 11.45 12.07 12.98
HOA dues: $1,040 ($1,300 x 80%) 14.0% 11.85 12.44 13.32
3. Maximum mortgage at 8%: $141,600 ($1,040 divided by 14.5% 12.25 12.80 13.66
7.34 multiplied by 1,000, (7.34 is the interest rate factor for a

8.00%, 30 year mortgage)
Our pre-qualification efforts should include an extra
Table 4-1
calculation which is designed to answer a second question: If
the maximum mortgage amount is not enough to qualify me to
purchase the house I want, by how much does the interest rate have to be reduced in order to qualify?
In the above case, we have pre-qualified someone for a mortgage amount of $141,600. Let us assume
that the applicant needs a mortgage amount of $165,000 and does not have the compensating factors in
order to exceed the ratios and still achieve loan approval. In this case:
Maximum Mortgage Payment: $1,040
Mortgage Amount Needed: $165,000 1,040 divided by 165 = 6.30
If we look on the payment factor chart located in Table 4-1, 6.30 is the payment factor on a 30 year
mortgage at 6.50%. Therefore, the interest rate would have to be reduced from 8% to 6.50% (either
through an adjustable rate mortgage or a temporary buydown) in order for the purchaser to qualify.
75
Chapter 4
If one finds these calculations cumbersome, the following tables simplify this process. First, Table 4-
2 allows you to take a maximum mortgage payment and convert it to a mortgage amount at different
interest rates. It assumes that taxes, insurance, and homeowners association dues will be 20% of the total
mortgage payment.
Table 4-3 actually qualifies typical incomes. It starts with an income, multiplies by the standard hous-
ing ratio of 28% and gives maximum mortgage payments, maximum mortgage amounts and maximum
monthly debts allowed at that payment (assumed to be 8% of income, or the difference between 28% and
36%). To use this table, find the column with your approximate income, and the row with your approxi-
mate interest rate, and find the cell where these two intersect. This cell contains three values. The top value
in that cell is the maximum mortgage amount, the middle value is the maximum monthly mortgage
payment amount, and the bottom value is the maximum monthly debts allowed at the given payment
amount.
Mortgage Amounts for Given Payments

Assuming 80% of total payment is for Principal and Interest (P&I)
and a 30 year fixed-rate loan
Total Mortgage Payments (PITI)
Interest
Rate $500 $800 $1,000 $1,200 $1,500 $2,000 $2,500 $3,000
5.0% $74,513 $119,220 $149,025 $178,830 $223,538 $298,051 $372,563 $447,076
5.5% $70,449 $112,718 $140,897 $169,077 $211,346 $281,795 $352,244 $422,692
6.0% $66,717 $106,747 $133,433 $160,120 $200,150 $266,867 $333,583 $400,300
6.5% $63,284 $101,255 $126,569 $151,882 $189,853 $253,137 $316,422 $379,706
7.0% $60,123 $96,197 $120,246 $144,295 $180,369 $240,492 $300,615 $360,738
7.5% $57,207 $91,531 $114,414 $137,297 $171,621 $228,828 $286,035 $343,242
8.0% $54,513 $87,221 $109,027 $130,832 $163,540 $218,054 $272,567 $327,080
8.5% $52,021 $83,234 $104,043 $124,851 $156,064 $208,086 $260,107 $312,129
9.0% $49,713 $79,540 $99,425 $119,311 $149,138 $198,851 $248,564 $298,276
9.5% $47,571 $76,113 $95,141 $114,170 $142,712 $190,283 $237,853 $285,424
10.0% $45,580 $72,929 $91,161 $109,393 $136,741 $182,321 $227,902 $273,482
10.5% $43,728 $69,965 $87,457 $104,948 $131,185 $174,913 $218,642 $262,370
11.0% $42,003 $67,204 $84,005 $100,806 $126,008 $168,010 $210,013 $252,015
11.5% $40,392 $64,627 $80,784 $96,941 $121,176 $161,569 $201,961 $242,353
12.0% $38,887 $62,220 $77,775 $93,330 $116,662 $155,549 $194,437 $233,324
12.5% $37,479 $59,967 $74,958 $89,950 $112,438 $149,917 $187,396 $224,875
13.0% $36,160 $57,856 $72,320 $86,784 $108,480 $144,639 $180,799 $216,959
13.5% $34,922 $55,875 $69,844 $83,813 $104,766 $139,688 $174,610 $209,532
14.0% $33,759 $54,014 $67,518 $81,021 $101,277 $135,036 $168,795 $202,554
Table 4-2
76
Credit Scores
In the past few years, lenders have been using automated credit scores to determine whether a borrower's
credit history meets loan approval. Though credit scores alone do not constitute the only decision making
factor, they are an important factor within the overall approval process. Basically, automated systems are
able to look at the facets of a credit history from a standpoint of predicting whether a particular consumer
represented an unreasonable risk of defaulting on the loan. The analysis of the performance of thousands
of mortgage payment histories matched to their owner's credit histories enabled Fair, Isaac and Co. (FICO
scores) and CCN-MDS (MDS scores) to develop what are called credit scores. The FICO scores can also
be referred to as Beacon (Equifax) , Empirica (Trans Union) and The TRW/Fair, Isaac Model (TRW)
depending upon which national credit data repositories report these scores.
The good news is that evaluating a credit history is no longer as subjective a process. If a borrower
has a low FICO score (below 620) or a high MDS score (over 700), they are considered a high credit risk.
If they have a high FICO score (over 660) or a low MDS score (under 550), they are considered a below
average risk.
What does this mean for the consumer? The information which determines credit scores is compiled
by credit bureaus who have been scrutinized for not being accurate at all times. Therefore, it is incumbent
upon all consumers to review their credit information and correct all inaccuracies. Remember the auto-
mated adage always applies: garbage in, garbage out. If you are buying a home you should also realize
that many loan programs exist for those with lower scores, but these may require higher rates or larger
down payments. In an effort to "demystify" the process, in June of 2000, Fair, Isaac and Company made
public a list of the factors used in determining credit scores as well as introducing a web-based service to
explain individual credit scores (http://www.fairisaac.com). This explanation indicates that the most im-
portant factors determining credit scores are payment histories and amounts owed on credit accounts.
Fannie Mae and Freddie Mac have incorporated credit scoring into their credit evaluation process.
For example, on 1-unit properties, Freddie Mac has instructed lenders to perform different levels of re-
view for different credit scores. A FICO score of over 660 would require a basic review. A FICO score of
620 to 660 would require a more comprehensive review of the file. A FICO score of less than 620
indicates that a lender should be cautious. Freddie Mac has indicated to lenders that these are not ap-
proval levels. A FICO score below 620 can be approved—but the file is to be looked at very closely.
FICO Scores below 620 which cannot be approved with compensating factors though the agencies
many times will fall within the categories of A- to D credit non-conforming lending. There is more
information regarding non-conforming mortgages within Chapter 2. Freddie Mac has released a program
for lending to borrowers with an A- credit rating as well.
In recent years Fannie Mae and Freddie Mac have developed technologies which furthers their review
of automated credit scores in the form of sophisticated automated underwriting systems. The Freddie Mac
system is known as Loan Prospector and the Fannie Mae system is called Desktop Underwriter. These
systems utilize credit scores and other factors to rate loans and make underwriting decisions. Automated
Underwriting Systems are changing the loan process significantly. A high rating might allow less under-
writing documentation, a smaller down payment or higher underwriting ratios than normally would be
required. A lower rating might require a rate premium. Automated Underwriting Systems are also being
developed for non-conforming alternatives—including B/C credit loans. Through these systems, under-
writing decisions are becoming more rapid and more uniform throughout the industry.
77
Chapter 4
Mortgage Qualification by Income and Interest Rate

Assuming 28% of income for house payment, 8% for debts,
and a 30 year fixed-rate loan
Monthly Income
Interest
Rate $1,500 $2,000 $2,500 $3,000 $4,000 $5,000 $7,500 $10,000
$78,2381 $104,318 $130,397 $156,477 $208,635 $260,794 $391,191 $521,589
5.0% $4202 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$1203 $160 $200 $240 $320 $400 $600 $800
$73,971 $98,628 $123,285 $147,942 $197,256 $246,570 $369,856 $493,141
5.5% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$70,052 $93,403 $116,754 $140,105 $186,807 $233,508 $350,262 $467,017
6.0% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$66,449 $88,598 $110,748 $132,897 $177,196 $221,495 $332,243 $442,990
6.5% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$63,129 $84,172 $105,215 $126,258 $168,344 $210,431 $315,646 $420,861
7.0% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$60,067 $80,090 $100,112 $120,135 $160,180 $200,225 $300,337 $400,449
7.5% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$57,239 $76,319 $95,398 $114,478 $152,638 $190,797 $286,195 $381,594
8.0% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$54,623 $72,830 $91,038 $109,245 $145,660 $182,075 $273,113 $364,150
8.5% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$52,198 $69,598 $86,997 $104,397 $139,196 $173,995 $260,992 $347,989
9.0% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$49,949 $66,599 $83,249 $99,898 $133,198 $166,497 $249,746 $332,995
9.5% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$47,859 $63,812 $79,766 $95,719 $127,625 $159,531 $239,297 $319,062
10.0% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$45,915 $61,220 $76,525 $91,829 $122,439 $153,049 $229,574 $306,098
10.5% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$44,103 $58,804 $73,504 $88,205 $117,607 $147,009 $220,513 $294,018
11.0% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$42,412 $56,549 $70,686 $84,824 $113,098 $141,373 $212,059 $282,745
11.5% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$40,832 $54,442 $68,053 $81,663 $108,885 $136,106 $204,158 $272,211
12.0% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$39,353 $52,471 $65,589 $78,706 $104,942 $131,177 $196,766 $262,355
12.5% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$37,968 $50,624 $63,280 $75,936 $101,248 $126,559 $189,839 $253,119
13.0% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$36,668 $48,891 $61,113 $73,336 $97,781 $122,227 $183,340 $244,453
13.5% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
$35,447 $47,262 $59,078 $70,894 $94,525 $118,156 $177,234 $236,312
14.0% $420 $560 $700 $840 $1,120 $1,400 $2,100 $2,800
$120 $160 $200 $240 $320 $400 $600 $800
1 = Maximum Mortgage Amount 2 = Maximum Monthly Mortgage Payment 3 = Maximum Monthly Debts
Table 4-3
78
Currently, FHA and VA do not use credit scores as a part of these

Residual method
underwriting guidelines. However, government loans can be underwrit-
ten utilizing these automated underwriting systems and this in effect brings Gross monthly income
(-) Income and payroll
credit scores into play for government loans. taxes
(-) Monthly debts
The residual method of qualification (-) Family support
(-) Housing expense
While the ratio method of qualification calculates a percentage of in- = (+) or (-) Residual
come which can be applied to the housing and debt payments of an
applicant, the residual method of qualification actually attempts to
more directly calculate whether the applicant can afford the monthly
VA Family Support
Table of Residuals
mortgage payment. We can think of the residual method of qualifi-
cation as the family budget method. That is, we take the income and Family Midwest
Size Northeast / South West
then subtract all expenses including the mortgage payment. If there 1 375/433 367/424 409/472
is a positive residual, the applicant qualifies. If there is a negative 2 629/726 616/710 686/791
residual, the applicant does not qualify. 3 758/874 742/855 826/952
4 854/986 835/964 930/1074
Almost everyone can relate to the calculation of a family budget:
5 886/1021 867/999 965/1113
income minus expenses. Yet, the calculation of the residual method
is much more tedious than the ratio method because of the number of Notes:
expenses which must be subtracted from the income: 1. First number in each column applies to
loan amounts below $80,000. The
•Federal income taxes•State income taxes•Social second number applies to loan amounts
Security•Rental negative•Child support•Family of at least $80,000.
2. Northeast Region: Connecticut, Maine,
Support•Monthly debts•Property taxes•Utilities•Housing Massachusetts, New Hampshire, New
maintenance•Association fees•Principal and interest Jersey, New York, Pennsylvania, Rhode
Island, and Vermont.
The cumbersome method of calculation may very well be a major 3. West Region: Alaska, Arizona, California,
reason why the majority of the industry has adopted the ratio method Colorado, Hawaii, Idaho, Montana,
Nevada, New Mexico, Oregon, Utah,
of qualification over the residual method. VA is the only major Washington, and Wyoming.
mortgage source continuing to rely on the residual method, though 4. All other states are under Midwest or
South Regions.
residual method continues to be an acceptable demonstration of 5. Active duty servicemen and/or their
affordability when a mortgage applicant needs to show compensating families living close to a military base
and receiving benefits of such can
factors in order to exceed acceptable ratios on jumbo mortgages: reduce required residual by 5.0%.
Monthly income: $10,000 6. Add $75 for each family member above
5 (up to 7). Over $80,000 loan amounts
Monthly debts: $2,000 (Alimony payment) add $80 for each family member.
Monthly PITI: $2,500
Debt ratio: 45% Table 4-4
In the above case, the debt ratio is 45%, much higher than the acceptable 36% conventional ratios.
From a residual point of view, however, it can be seen that the applicant has plenty of disposable income,
especially because the alimony payment is tax deductible:
Monthly Income: $10,000
Taxes: (-) $ 2,000
Debts: (-) $ 2,000
PITI: (-) $ 2,500
Residual: $ 3,500 For utilities, maintenance, family support
We will end this discussion of ratios and residuals with worksheets which combine the ratio and
residual method and also present many notes which will help you work out qualification solutions. The
pre-qualification worksheets walk you through an extra calculation to determine the lower interest rate
needed for a larger mortgage amount. These are excellent pages for home buyers, real estate agents, and
loan originators to copy and use for multiple qualification and pre-qualification questions.
79
Chapter 4
Residual Method Example

Residual method example Borrower Co-Borrower
Monthly gross income _ 2,000 __ 1,000
Residual method
Federal Tax (-) _ 181 __ _ 31
example assumptions
State Tax (-) _ ___ __ _ 50
Assumptions: Social Security (-) _ 153 ___ 77
Husband and Wife
No Children Retirement (-) _ ____ ________
Property Taxes: $200 Monthly
Husband Income: $2,000 Taxable
Child Care (-) _ _ ____ ________
Spouse Income: $1,000 Taxable Monthly Debts (-) 750 ________
$840 Non-
taxable 37 Rental Negative (-) _ _ __ __ ________
Association Fees: $50 Monthly
Hazard Insurance: $25 Monthly
Non-taxable Income (+) 840 ________
Interest Rate: 8.5% Subtotal 1,746 __ 832
Mortgage Amount: $165,000
Debts: $350 Car Loan
150 Personal Total _ 2,578
Loan
$250 Monthly Taxes & Insurance (-) _ 225
Credit Utilities (-) _ 215
Cards
Maintenance (-) _ 50
Monthly tax chart Association Fee (-) _ 50
Withholding Family Support (-) _ 726
If Wages Are Allowances
But Balance available for
At 0 1 2
Least Less principal and interest (=) _ 1312
Than
960 1000 66 31 0 $165,000 at 8.5% (-) _ 1269
1960 2000 216 181 146 Positive Residual __ +63
Notes:
• The Federal taxes are taken from example above. Actual tax tables are located in the Appendices. In this case we
would use the married table with one exemption for each borrower.
• The State taxes are estimated at five percent of gross monthly income. This figure will change slightly from state to
state. In addition, many states exempt income of the military from taxation.
• Social Security taxes are 7.65% of all taxable income in this case.
• Separate retirement may be paid by Federal, State and Local government employees. Military personnel do not
contribute to their retirement plans.
• Rental negative would be in the case of another property owned by the applicants, and rented out to others. VA
requires a veteran to have experience as a landlord in order to count rental income: as well as three months of
mortgage payments as cash reserves after closing. On a multiple unit property purchase, the veteran is required to
have six months cash reserves after closing.
• Monthly utilities is estimated at $1 per thousand plus $50 ($100,000 sales price would be $150 monthly).
• Maintenance: we usually estimate $50 for maintenance except for condominiums because the condominium
assessment would cover a certain amount of maintenance. In the case of condominiums we would use $25.
• Family support is from a table issued by the VA. The number used would depend upon the region of the country and
the family size. In addition:
– VA allows a 5% reduction in the required family support if the house is located near a military base and the
veteran enjoys benefits from that base.
– VA requires a 20% increase in family support if the debt ratio of the applicant(s) exceeds the required 41%. A
positive residual with the 20% increase in family support is not mandatory, but is considered a significant
compensating factor for anyone exceeding the 41% back ratio.
• Hazard insurance is from assumptions above. A general estimate is $2.50 for each $1,000 of sales price.
37
Husband is active military and in addition to taxable base income he receives variable housing allowances, or VHA, Basic Allowance
for Subsistence, or BAS, and Basic Allowance for Quarters, or BAQ, each of which is not taxable.
80
Purchaser Qualification Sheet

Date _______________________
Purchaser _____________________ Down payment & closing costs ____________
Property ______________________ Liquid assets available ____________________
RATIO RESIDUAL
(B) (C)
A. Monthly gross income . ______ (A) Monthly gross income ... _______ ______
B. Housing expense ........... ______ Federal Tax (-) .................... _______ ______
Principal and Interest ......... ______ State Tax (-) ........................ _______ ______
Taxes and Insurance ......... ______ Social Security (-) ............... _______ ______
MI ...................................... ______ Retirement (-) ..................... _______ ______
Association Fee ................ ______ Child Care (-) ...................... _______ ______
PI for second Trust ........... ______ Monthly Debts (-) ................ _______ ______
Total ................................. ______ (B) Rental Negative (-) .............. _______ ______
C. Debt service ................... ______ Non-taxable Income (+) ...... _______ ______
Housing Expense (B) ....... ______ Subtotal ............................ _______ ______
Monthly Debt Payments .... ______ Total .............................................. _______
Rental Negatives ............... ______ Taxes & Insurance (-) ................... _______
Total ................................. ______ ( C ) Utilities (-) ..................................... _______
Housing Ratio: Maintenance (-) ............................ _______
(B) divided by (A) ......... ____ % Association Fee (-) ....................... _______
Debt Ratio: Family Support (-) ......................... _______
(C) divided by (A) ........ ____ % Balance available for principal
and interest ................................ _______
NOTES:
1. Income must be averaged if variable (interest, commission, bonus, overtime, part-time). For self-employed use
average of Net income for 2 years. Do not include expense accounts.
2. Debts: Monthly payments with more than 10 months remaining.
Child support and/or alimony payments are monthly debts (child care only for VA).
For credit cards use 5% of the outstanding balance or minimum of $10. For FHA, alimony can be taken as a
reduction in income.
3. Rental negative: A vacancy factor of 7% - 25% for FHA/VA loans and 25% for conventional loans may be used
to lower monthly rental income before a negative is calculated ($1,000 income with 25% factor is $750).
4. PI for a second trust is in the first ratio only if secured on property being purchased.
5. Association fee is included in first ratio in full. Condo fees that include utilities are sometimes reduced 30-40%.
Condo fee in VA qualifying will reduce estimates for maintenance, insurance, and sometimes utilities.
6. Social security for 2001 is 7.65% and 15.30% for self employed on a maximum base of $80,400. Medicare
Portion only (1.45% and 2.90%) is collected above that amount.
7. Federal retirement is 8.5% with no maximum.
8. State income tax is not paid by many active military.
9. Utilities is $1 per 1,000 of sales price + $50.
10. Maintenance: $50 estimate; $25 for condominiums.
11. Insurance: Estimate $2.50 per 1,000 of sales price for annual premium.
12. Mortgage Insurance (MI) estimate 1.04% monthly for 97% LTV, .67 monthly for 95% LTV, .39% monthly for 90% LTV.
Worksheet 4-1
81
Chapter 4
Conventional Pre-Qualification
FIRST RATIO
Monthly Gross Income ____________
x .28
Less Property Taxes (-) __________
Less Hazard Insurance (-) __________
Less Mortgage Insurance (-) __________
Less HOA or Condo Fee (-) __________
Available for Principal & Interest (A) $___________
SECOND RATIO
Monthly Gross Income ____________
x .36
Less Monthly Debts (-) __________
Less Property Taxes (-) __________
Less Hazard Insurance (-) __________
Less Mortgage Insurance (-) __________
Less HOA or Condo Fee (-) __________
Available for Principal & Interest (B) $___________
Divide the lower of (A) or (B) above by interest

rate factor per $1,000 which is prevailing for ÷ (factor)
program desired at time of
pre-qualification =
Multiply answer by 1,000 to arrive at x 1,000

maximum loan amount
=$ maximum loan
To figure interest rate needed to qualify borrower when loan amount needed is known:
Carry lower of (A) or (B) above down to right $_________

Divide by loan amount, dropping the last three numbers (ex: $70,000 = 70) ÷_________
Result is interest rate factor (Table on inside cover) __________
Worksheet 4-2
82
VA Pre-Qualification — Residual
(B) (CB)
Monthly Gross Income __________________ __________________
Less Federal Tax (-) __________________ (-) __________________

Less State Tax (-) __________________ (-) __________________
Less Social Security (-) __________________ (-) __________________
Less Child Care (-) __________________ (-) __________________
Less Monthly Debts (-) __________________ (-) __________________
Less Rental Negative (-) __________________ (-) __________________
Add Non-taxable Income (+) __________________ (+) __________________
Sub-Total __________________ __________________
Total __________________
Less Property Taxes (-) __________________
Less Hazard Insurance (-) __________________
Less Utilities (-) __________________
Less Maintenance (-) __________________
Less Association/Condo Fees (-) __________________
Less Family Support (-) __________________
Available for Principal & Interest __________________
Divide the principal & interest by interest

rate factor per $1,000 which is prevailing for divide by __________________ (factor)
program desired at time of
pre-qualification = __________________
Multiply answer by 1,000 to arrive at x __________________

maximum loan amount
=$ __________________ max loan
To figure interest rate needed to qualify borrower when loan amount needed is known:
Carry principal and interest down to right $ ___________

Divide by loan amount, dropping the last three numbers (ex: $70,000 = 70) ÷ ___________
Result is interest rate factor (Table on inside cover) _____________
Worksheet 4-3
83
Comparing Mortgages
5
Comparing Mortgages
Thus far we have presented the characteristics of a multitude of mortgage
types and sources. This information was imperative in order to arrive at the
answer for the most significant question of this book:
“Which is the best mortgage alternative for me?”
?
Unfortunately, there may very well be no clear cut answer to this ques-
tion. Many mortgage applicants have very little choice when it comes to se-
lecting a mortgage. This is because of limited cash assets and/or income nec-
essary to qualify for the mortgage. Others have a choice but lack direction as
to the proper way to compare mortgages. In the final analysis, even the most
qualified and informed consumer still may not be able to make the best choice
because there are always two undetermined variables at the time of mortgage
selection:
• For how long will the mortgage be utilized?
• Where will interest rates move in the future?
If we could determine the answers to these questions, the selection of mortgage alternatives would be
much simpler. Since it is unlikely that the prediction of the future will be within our reach, we will make
any decision with a good measure of uncertainty. What we are forced to do is make assumptions about the
future and then compare our alternatives under these assumptions. We then try to select from the scenario
with which we are the most comfortable.
Comparing mortgage payments over the life of the mortgage

The cost of the mortgage over the life of the mortgage is obviously the consumer's main concern after
home and/or mortgage acquisition has taken place. It is here that we must factor in the unknown variables
of expected mortgage life and the future direction of interest rates. Let us take a simple example:
The choice is: $100,000 mortgage
a. 8.00% 30 year fixed rate
b. 5.00% one year adjustable
2.00% annual cap
6.00% life cap
2.75% margin over one year T index
85
Chapter 5
In the first year, it is easy to see that the payments will be lower Worst case scenario example
for the adjustable. If the mortgage has a five year life, what will Year 1: 5.00%
happen? Will the adjustable rate mortgage increase two percent ev- Year 2: 7.00%
Year 3: 9.00% $776.01 average
ery year? payments
If the adjustable increases by the maximum allowed under the Year 4: 11.00%
Year 5: 11.00% (11% is the life cap)
adjustment caps, we are describing the worst case scenario. The worst 43.00%
case scenario for our one year adjustable over a five year period is
shown in the example. 43.00% ÷ 5 = 8.60% average
How do we compare this scenario to the fixed rate? The easiest way is to average the interest rate over
the five year period: 8.60%. Comparing payments over the period:
One year ARM: 8.60% $46,560 total payments
30 year fixed: 8.00% $44,025 total payments
Savings on fixed rate: $ 2,535
We should bring forward the following notations on this comparison:
1. The risk of the ARM averaging a higher rate
than the fixed rate rises over time in the worst 5 previous years model comparison
case scenario. The average rate over four years Date of Mortgage: January 1, 1995
for the ARM is actually identical to that of the Interest rate year 1: 5.00%
Interest rate year 2: 7.00% (index value January 1, 1996:
fixed rate. 9.05 + 2.75 = 11.80%, which is higher
2. This analysis does not take into account of cost Interest rate year 3: than 2% annual cap)
9.00% (index value January 1, 1997:
of money over time. The cost of money paid 7.92 + 2.75 = 10.67%, which is higher
out in the future is worth less due to the existence than 2% annual cap)
Interest rate year 4: 9.50% (index value January 1, 1998:
of inflation. 6.64 + 2.75 = 9.39%, or 9.5% rounded
3. The worst case scenario actually presents Interest rate year 5: up to nearest .125%)
7.50% (index value January 1, 1999:
adjustables in a negative light and this scenario 4.38 + 2.75 = 7.13%, which is lower than
is not the only valid method of comparison. For 2% annual cap)
Average rate 7.60%, less than 30-year fixed
example, suppose we assumed that the mortgage
was procured five years ago and we compare
FIAR example
the average payments which would have 5% One year arm
occurred over the past five years as a model of 2/6 Caps
2.75 Margin
prediction for the next five years? Index value at the time of settlement: 7.00
Interest rate year 1: 5.00%
The example shows an average rate of 7.60% Interest rate year 2: 7.00% (7.00 + 2.75 = 9.75%, which is
over five years, which is exactly 1% less than the higher than 2% annual cap)
average rate under the worst case scenario and less Interest rate year 3: 9.75% (7.00 + 2.75 = 9.75%, which is
higher than 2% annual cap)
than the 8.00% fixed rate. Interest rate year 4: 9.75% (7.00 + 2.75 = 9.75%, which
means that ARM has reached its FIAR)
Another option for developing a scenario for pre- Interest rate year 5: 9.75% (this rate will hold for the term of
dicting the behavior of an adjustable rate mortgage the mortgage as we assume the index is
stable)
is to assume that the index value stays constant at Average rate for 5
the time of settlement for the life of the mortgage. years: 8.10%, virtually the same as the fixed
rate in the example.
This means that the adjustable rate mortgage will
rise to the Fully Indexed Accrual Rate, or FIAR.
86
Comparing Mortgages
Which computation method is

Worst Case Scenario Comparison for Different
more accurate: the worst case, past Mortgage Types
track record, or FIAR scenario for
ARMs? There is no way of know- Mortgage amount: $100,000
ing. Each has some element of *30 year fixed rate of 8.00
*2-1 buydown of 30 year fixed rate of 8.25%
merit: *Three year adjustable at 6.50%
• The worst case scenario 2% cap every 3 years
6% life cap
enables the consumer to *One year adjustable at 6.00%
determine the worst that can 1% annual cap
happen during the loan term. 4% life cap
It is also to become more
30 Year 2-1 Three One
likely if the ARM was Year Fixed Buydown Year Year
originated below market (with 1 8.0% 6.25% 6.5% 6.0%
a teaser rate) or market rates 2 8.0% 7.25% 6.5% 7.0%
are much lower than historical 3 8.0% 8.25% 6.5% 8.0%
4 8.0% 8.25% 8.5% 9.0%
standards. 5 8.0% 8.25% 8.5% 10.0%
• The past track record enables 6 8.0% 8.25% 8.5% 10.0%
the consumer to look back and
Average Rate: 8.0% 7.75% 7.5% 8.33%
determine how the ARM Average Payment: $733.76 $716.41 $699.21 $756.90
would have performed under Total Payments: $52,831 $51,581 $50,343 $54,497
market conditions that were in
effect for the period directly
before the settlement takes place. This would become more likely if the period utilized for comparison
is not one which varied significantly from historical standards.
• The FIAR method assumes that today's market will be the standard for the future. This is to be more
likely if today's market is typical of historical standards.
The borrower actually should look at the performance of an ARM product under several conditions:
the worst case, declining rates, and volatile rates. In this way the borrower will have an idea of all
performances which are possible.
Because these calculations would be quite tedious for the average home buyer, we have developed
some tables which should help in the determination of the performance level of different adjustable rate
products under different scenarios.
Table 5-1 gives the average rates for each product type described under a worst case scenario for a
certain time period. For example, the one year ARM with 2/6 caps will average 1% over the start rate for
a two year period. One can now use this table to compare any products with identical characteristics by
just knowing the start rates.
Example: One year ARM Example: Three year ARM
Start rate of 5% Start rate of 7%
Average rate for two Average rate for five
years: 6% (5% + 1%) years: 7.8% (7% + 0.8% )
87
Chapter 5
Interest Rate Increases for Variable Mortgages

Average interest rate increase as of given year
Assuming 0% start rate and worst case rate increase (5% Increase for balloons)
6 mo. ARM 1 year 1 year 3 year 3/1 ARM 5 year 5/1 ARM
2-1 with 2/6 ARM with ARM with ARM with with 2/6 ARM with with 2/6 5/25 7/23
Year Fixed Buydown Caps 2/6 Caps 1/4 Caps 2/6 Caps Caps 2/6 Caps Caps Balloon Balloon
1 0.0% 0.0% 0.5% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
2 0.0% 0.5% 1.5% 1.0% 0.5% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
3 0.0% 1.0% 2.5% 2.0% 1.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
4 0.0% 1.3% 3.4% 3.0% 1.5% 0.5% 0.5% 0.0% 0.0% 0.0% 0.0%
5 0.0% 1.4% 3.9% 3.6% 2.0% 0.8% 1.2% 0.0% 0.0% 0.0% 0.0%
6 0.0% 1.5% 4.3% 4.0% 2.3% 1.0% 2.0% 0.3% 0.3% 0.8% 0.0%
7 0.0% 1.6% 4.5% 4.3% 2.6% 1.4% 2.6% 0.6% 0.9% 1.4% 0.0%
8 0.0% 1.6% 4.7% 4.5% 2.8% 1.8% 3.0% 0.8% 1.5% 1.9% 0.6%
9 0.0% 1.7% 4.8% 4.7% 2.9% 2.0% 3.3% 0.9% 2.0% 2.2% 1.1%
10 0.0% 1.7% 5.0% 4.8% 3.0% 2.4% 3.6% 1.0% 2.4% 2.5% 1.5%
11 0.0% 1.7% 5.0% 4.9% 3.1% 2.7% 3.8% 1.3% 2.2% 2.7% 1.8%
12 0.0% 1.8% 5.1% 5.0% 3.2% 3.0% 4.0% 1.5% 2.0% 2.9% 2.1%
13 0.0% 1.8% 5.2% 5.1% 3.2% 3.2% 4.2% 1.7% 1.8% 3.1% 2.3%
14 0.0% 1.8% 5.3% 5.1% 3.3% 3.4% 4.3% 1.9% 1.7% 3.2% 2.5%
15 0.0% 1.8% 5.3% 5.2% 3.3% 3.6% 4.4% 2.0% 1.6% 3.3% 2.7%
16 0.0% 1.8% 5.3% 5.3% 3.4% 3.8% 4.5% 2.3% 1.5% 3.4% 2.8%
17 0.0% 1.8% 5.4% 5.3% 3.4% 3.9% 4.6% 2.5% 1.4% 3.5% 2.9%
18 0.0% 1.8% 5.4% 5.3% 3.4% 4.0% 4.7% 2.7% 1.3% 3.6% 3.1%
19 0.0% 1.8% 5.4% 5.4% 3.5% 4.1% 4.7% 2.8% 1.3% 3.7% 3.2%
20 0.0% 1.9% 5.5% 5.4% 3.5% 4.2% 4.8% 3.0% 1.2% 3.8% 3.3%
21 0.0% 1.9% 5.5% 5.4% 3.5% 4.3% 4.9% 3.1% 1.1% 3.8% 3.3%
22 0.0% 1.9% 5.5% 5.5% 3.5% 4.4% 4.9% 3.3% 1.1% 3.9% 3.4%
23 0.0% 1.9% 5.5% 5.5% 3.6% 4.4% 5.0% 3.4% 1.0% 3.9% 3.5%
24 0.0% 1.9% 5.6% 5.5% 3.6% 4.5% 5.0% 3.5% 1.0% 4.0% 3.5%
25 0.0% 1.9% 5.6% 5.5% 3.6% 4.6% 5.0% 3.6% 1.0% 4.0% 3.6%
26 0.0% 1.9% 5.6% 5.5% 3.6% 4.6% 5.1% 3.7% 0.9% 4.0% 3.7%
27 0.0% 1.9% 5.6% 5.6% 3.6% 4.7% 5.1% 3.8% 0.9% 4.1% 3.7%
28 0.0% 1.9% 5.6% 5.6% 3.6% 4.7% 5.1% 3.9% 0.9% 4.1% 3.8%
29 0.0% 1.9% 5.6% 5.6% 3.7% 4.8% 5.2% 3.9% 0.8% 4.1% 3.8%
30 0.0% 1.9% 5.7% 5.6% 3.7% 4.8% 5.2% 4.0% 0.8% 4.2% 3.8%
Table 5-1
Comparing mortgage payments for different mortgage terms

The consumer may actually desire higher mortgage payments if the result will be a shorter mortgage
term. In this case, the consumer's goal will be to build up equity as quickly as possible, or reducing the
interest owed over the life of the mortgage. Table 5-2 actually compares the total mortgage payments over
the mortgage term and total interest paid for varied interest rates on a $100,000 mortgage.
The consumer can actually use these tables for any mortgage amount by a process of extrapolation:
• A mortgage amount of $150,000 would be 1.5 times any value in the tables
• A mortgage amount of $50,000 would be one-half of any value in the tables
88
Comparing Mortgages
Mortgage Term/Prepayment Comparison

Assuming $100,000 loan amount and 25% tax rate
Additional Lifetime
Term Monthly Monthly Payment Total Interest Total of Savings vs.
Rate (Years) Payment vs. 30-Year Paid Payments 30-Year Term
7% 10 $1,161.08 $495.78 $39,330 $139,330 $100,179
15 $898.83 $233.53 $61,789 $161,789 $77,720
20 $775.30 $110.00 $86,072 $186,072 $53,437
25 $706.78 $41.48 $112,034 $212,034 $27,475
30 $665.30 $0.00 $139,509 $239,509 $0
8% 10 $1,213.28 $479.51 $45,593 $145,593 $118,562
15 $955.65 $221.89 $72,017 $172,017 $92,138
20 $836.44 $102.68 $100,746 $200,746 $63,410
25 $771.82 $38.05 $131,545 $231,545 $32,610
30 $733.76 $0.00 $164,155 $264,155 $0
9% 10 $1,266.76 $462.14 $52,011 $152,011 $137,653
15 $1,014.27 $209.64 $82,568 $182,568 $107,096
20 $899.73 $95.10 $115,934 $215,934 $73,730
25 $839.20 $34.57 $151,759 $251,759 $37,905
30 $804.62 $0.00 $189,664 $289,664 $0.00
10% 10 $1,321.51 $443.94 $58,581 $158,581 $157,345
15 $1,074.61 $197.03 $93,429 $193,429 $122,497
20 $965.02 $87.45 $131,605 $231,605 $84,321
25 $908.70 $31.13 $172,610 $272,610 $43,316
30 $877.57 $0.00 $215,926 $315,926 $0
11% 10 $1,377.50 $425.18 $65,300 $165,300 $177,536
15 $1,136.60 $184.27 $104,587 $204,587 $138,249
20 $1,032.19 $79.86 $147,725 $247,725 $91,111
25 $980.11 $27.79 $194,034 $294,034 $48,802
30 $952.32 $0.00 $242,836 $342,836 $0
12% 10 $1,434.71 $406.10 $72,165 $172,165 $198,135
15 $1,200.17 $171.56 $116,030 $216,030 $154,270
20 $1,101.09 $72.47 $164,261 $264,261 $106,040
25 $1,053.22 $24.61 $215,967 $315,967 $54,333
30 $1,028.61 $0.00 $270,301 $370,301 $0
Table 5-2
We should note that if we merely compared the mortgage payments and interest paid over the term,
we would not be able to realize the opportunity cost of not being able to invest certain money during the
life of the mortgage. For example, if a 15 year mortgage requires an extra payment of $400 each month as
compared to a 30 year instrument, the home owner could invest this $400 each month in a bank account
or mutual fund. The investment income will partially offset the interest savings on the 15 year mortgage.
Another factor which is even harder to measure is the effect of deducting the taxes on the interest pay-
ments. Any interest savings will actually reduce the tax deductible portion of the mortgage, thereby
increasing the consumer's tax base. Of course, the investment interest gained will also be taxable.
89
Chapter 5
Comparing points on mortgage programs

It is one thing to compare the performance of different mortgage instruments using the starting rates
and potential rate increases in the future. What if the initial points charged are different? How does this
affect the comparison?
1. When comparing different products with different point options, we can adjust easily for each point
by adding one percent to the starting rate for each extra point charged.
For example:
Fixed rate of 8.00% with 2 points
One year ARM of 5.00% with 3 points
(2% annual cap/6% life cap)
When we provide the worst case scenario comparison, we add one percent to the starting rate of the
adjustable (for the first year only):
Fixed Rate Adjustable
Year 1: 8.00% 6.00% (instead of 5.00%)
Year 2: 8.00% 7.00%
Year 3: 8.00% 9.00%
Average rate: 8.00% 7.33%
Average rate without extra point: 7.00%
2. When comparing the same product with different point options, we are now trying to decide the
answer to this question:
“Should I choose a lower rate with more
points or a higher rate with lower points?”
Assuming you have the income necessary to qualify for any interest rate available, and possess the
cash assets necessary to pay any point options available, there remains only one factor important for
the determination of the answer:
How long will you have the mortgage?
Each extra point will be paid back over a period of time (from five to eight years typically) through a
lower payment.
Example:
$100,000 mortgage–30 year fixed rate
Option 1: 8.25% with 0 points
Option 2: 7.75% with 3 points
Monthly payment at 8.25%: $751.27
Monthly payment at 7.75%: $716.41
Monthly savings at 7.75%: $ 34.86
Extra cost of points at 8.25%: $ 3,000
Months to recover cost of points: $ 3,000
$34.86 = 86.06, or 7.17 Years
Our conclusion here is that the applicant will be better off paying the extra points if he/
she stays with the mortgage for over seven years. Generally, the longer one stays in the home, the
more likely that extra points will pay off. We should note that this analysis is not entirely accurate
because it compares points in today's dollars to future dollars with regard to monthly payments.
90
Comparing Mortgages
Once again we have developed Annual Percentage Rates

tables to help you in the determina- At varying terms and points
8% interest rate
tion of the value of points. Through
the Truth-In-Lending Disclosure Points
(TIL), the Federal Government tries Term
to standardize the cost of mortgages (years) 0 1 2 3 4 5
6 mo. 8.000% 11.497% 15.049% 18.657% 22.322% 26.047%
by combining extra fees with the in-
1 8.000% 9.895% 11.818% 13.770% 15.751% 17.762%
terest rate. The figure which is com-
2 8.000% 8.999% 10.012% 11.039% 12.082% 13.140%
piled and disclosed is called the An- 3 8.000% 8.684% 9.378% 10.082% 10.796% 11.520%
nual Percentage Rate, or APR. Table 4 8.000% 8.524% 9.055% 9.594% 10.141% 10.695%
5-3 assumes that the only extra costs 5 8.000% 8.427% 8.859% 9.298% 9.744% 10.196%
associated with the mortgage are 6 8.000% 8.362% 8.728% 9.101% 9.478% 9.861%
points. We are utilizing a standard 7 8.000% 8.315% 8.635% 8.959% 9.288% 9.622%
$100,000 mortgage and a base rate 8 8.000% 8.280% 8.564% 8.853% 9.145% 9.442%
of 8.00%. The table varies the points 9 8.000% 8.253% 8.510% 8.770% 9.034% 9.303%
10 8.000% 8.231% 8.466% 8.704% 8.946% 9.191%
paid and the life of the mortgage over
15 8.000% 8.167% 8.336% 8.508% 8.683% 8.860%
which the points are utilized.
20 8.000% 8.135% 8.273% 8.413% 8.555% 8.699%
25 8.000% 8.117% 8.237% 8.358% 8.481% 8.607%
Comparing cash 30 8.000% 8.106% 8.214% 8.324% 8.435% 8.549%
requirements for each
Table 5-3
mortgage
Sometimes the interest rate, payments, or points are not the overriding factors present within the
mortgage selection process. Sometimes the one most important factor is:
“Which mortgage will enable me to get into the house with the least amount of cash invested?”
Cash Necessary For Home Purchase
Cash Requirement FHA VA Conventional

Down Payment 1.25% to 2.85% 0 0 to 5.0%
Mortgage Insurance 0 0 0
Seller Contributions 6.0% All normal costs 3.0% with minimum down
Prepaids Seller can pay Seller can pay Varies
Total Cash 3.0% 0 3.0% to 5.0%
Gift 100% 100% Borrower may be required to
have 3.0% to 5.0% of own funds
Notes:
• Mortgage Insurance not counted if it can be financed (escrow amount will be included under prepaids).
• Cash requirements based upon average closing costs of 3.0% and prepaids of 1.0%.
• Maximum seller contributions assumed for determining total cash requirements.
• 100% gift means that the borrower can use a gift for all necessary funds.
• Lender can pay prepaids with higher interest rate on FHA and some conventional mortgages.
• In the case of VA, the borrower pays a funding fee rather than mortgage insurance.
• Conventional 0 to 3.0% down payment programs may require max. income or minimum credit score.
Table 5-4
91
Chapter 5
As we have presented different mortgage sources, we have attempted to focus on all differences
between these mortgage options. Table 5-4 will attempt to summarize one characteristic: the cash
necessary for home purchase.
Comparing qualification requirements for each mortgage source

Qualification requirements comprise another factor which can be the determining variable in selecting
a mortgage. The term and mortgage payment may not be relevant if the purchaser cannot purchase the
home because their income is insufficient to qualify for a mortgage. Table 5-5 summarizes the income
requirements for each mortgage source. These requirements are expressed in terms of mortgage ratios.
Qualification Requirements for Mortgage Sources
FHA VA Conventional
Housing ratio 29% N/A 28%-33%
Debt ratio 41% 41% 33%-38%
ARM standard Initial rate Second year rate Second year rate/minimum 7%
Temporary buydown Maximum 2% below Cannot qualify at Typically 2% below note rate
standard note rate reduced rate
Notes:
• VA has second standard of a positive residual
• ARM and temporary buydown standards are the rates at which the borrower will be qualified if these instruments
are utilized to increase qualification (assumes maximum LTV).
• VA will allow qualification at a reduced rate for a temporary buydown if the borrower provides proof of future
increase in income of a definitive amount.
Table 5-5
92
Refinancing a Mortgage
6
What is a refinance?
A refinance is the replacement of an existing mortgage with a new loan which could be equal to,
larger or smaller in size than the original mortgage. In fact, if there was never a mortgage placed upon
the property (we say that it is owned free and clear), placing a mortgage on the property for the first
time is considered a refinance as long as the owner remains the same. The placement of a second
mortgage behind a first mortgage on a property after it is purchased is called a refinance second, or
home equity second, as opposed to a purchase money second.
There are two basic types of refinance mortgages:
• A rate reduction refinance replaces only the existing balance. The new mortgage balance can be
increased to finance or roll in closing costs associated with procuring the new mortgage. It should
be noted that not all rate reduction refinances carry a lower interest rate than the original mortgage.
The important point is the primary purpose of the refinance,
which will be to pay off the original mortgage and finance as- Rate reduction refinance
sociated closing costs.
(with closing costs financed)
• A cash out refinance replaces more than the existing balance Existing mortgage
balance: $95,000
and associated closing costs. The new mortgage balance is large
Closing costs on
enough to pay off the existing balance and associated closing new mortgage: $ 3,000
costs and the home owner will walk away with cash from the Refinance mortgage
balance: $98,000
transaction. A second trust placed upon the property for the
purposes of pulling cash or equity out would be termed a home equity second. Second trusts which
open up lines of credit for future cash withdrawals would be called home equity lines of credit
(HELOCs).
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Chapter 6
Cash out refinance Why would someone want to refinance a

Existing mortgage home?
balance: $95,000
Closing costs on 1. Lower the interest rate and payment. The most obvious reason
new mortgage: $3,000
someone would want to refinance a mortgage would be to lower
Refinance mortgage
balance: $110,000 the interest rate and payment on that mortgage.
Cash out to home
owner: $12,000 In the above example, we rolled the costs into, or financed the
costs of, the refinance. This is the most common way to effect a
refinance. Another mode of comparison would be to assume the
home owner paid the costs of the refinance from his/her own
Rate and payment bank account. The costs would remain the same but the new
reduction refinance mortgage balance would be the same as the original loan.
Original mortgage
balance: $100,000 One method of comparison is not more accurate than the other.
Original interest rate: 10.5% One can not accurately measure the cost associated with increas-
Principal and interest ing the present mortgage balance, or decreased equity in the
payment: $914.74
Present mortgage home. Another cost which cannot be measured is the increased
balance: $98,500 term of the loan:
Closing costs: $1,800
Points: $1,200 • Original mortgage balance and term: $100,000 at 30 years
New mortgage balance: $101,500 • Present balance and remaining term: $ 98,500 at 28.5 years
New interest rate: 8.5% • New balance and term: $101,500 at 30 years
New principal and
interest payment: $780.45 The new mortgage will actually cause the term to increase by
Monthly savings: $134.29 one and one-half years. If the home owner will own the home
Total costs: $ 3,000 for this length of time without refinancing again, the extra cost
Months to recover costs: 22.34
($3,000 ÷ $134.29) at the end of the mortgage should be measured. Or, the terms
should be made equivalent in the comparison:
• Present mortgage payment: $914.74
• New mortgage payment: $789.60 at $101,500 balance
Costs paid out-of-pocket • 8.5% interest rate
New mortgage balance $98,500 • 28.5 years term
New principal and • Recalculated monthly savings: $125.14
interest payment: $757.38
• Recalculated recovery time: 23.97 months
Monthly savings: $157.36
Total costs: $3,000
Months to recover costs: 19.06
($3,000 ÷ $157.36)
94
At first glance, figuring the Months to Break Even After Refinance

monthly savings and recovery time Assuming 10% interest rate on existing mortgage
from reducing the interest rate is and no change in 30 year term
very simple: divide the costs of the
Cost of Refinance
refinance by the monthly savings
to arrive at the recovery period. In Interest
Rate
Payment
Reduction 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0%
reality, the actual monthly savings Reduction Factor
is not as easy to calculate as we fig- 0.25% 0.184 27.1 54.3 81.4 108.6 135.7 162.9 190.0 217.2
0.50% 0.367 13.6 27.2 40.9 54.5 68.1 81.7 95.3 108.9
ure in the factors of changing the 0.75% 0.549 9.1 18.2 27.3 36.4 45.5 54.6 63.8 72.9
loan term and financing the costs 1.00% 0.729 6.9 13.7 20.6 27.4 34.3 41.1 48.0 54.8
of the refinance. Since the length 1.25% 0.909 5.5 11.0 16.5 22.0 27.5 33.0 38.5 44.0
1.50% 1.087 4.6 9.2 13.8 18.4 23.0 27.6 32.2 36.8
of time the home owner will have
1.75% 1.263 4.0 7.9 11.9 15.8 19.8 23.8 27.7 31.7
the loan cannot be answered, the 2.00% 1.438 3.5 7.0 10.4 13.9 17.4 20.9 24.3 27.8
precise effect cannot be measured. 2.25% 1.612 3.1 6.2 9.3 12.4 15.5 18.6 21.7 24.8
Table 6-1 assumes that the costs 2.50% 1.784 2.8 5.6 8.4 11.2 14.0 16.8 19.6 22.4
2.75% 1.954 2.6 5.1 7.7 10.2 12.8 15.4 17.9 20.5
are paid out of pocket and do not 3.00% 2.123 2.4 4.7 7.1 9.4 11.8 14.1 16.5 18.8
consider any change in mortgage 3.25% 2.290 2.2 4.4 6.6 8.7 10.9 13.1 15.3 17.5
term. It predicts monthly savings 3.50% 2.455 2.0 4.1 6.1 8.1 10.2 12.2 14.3 16.3
and gives the number of months 3.75% 2.619 1.9 3.8 5.7 7.6 9.5 11.5 13.4 15.3
4.00% 2.780 1.8 3.6 5.4 7.2 9.0 10.8 12.6 14.4
until those savings equal the cost
of the refinance. Although it as- Note: to calculate monthly payment reduction, multiply the principal amount, in
thousands, by the Payment Reduction Factor in the second column.
sumes a 10% interest rate on the
existing mortgage, the savings dif- Table 6-1
ferentials will not vary much for interest rates from 5-15%, and for loan terms of 20-40 years.
In the example, the interest rate on a mortgage with $100,000
remaining principal was reduced from 10% to 7.50%. Using the Refinance Example
table, the 2.5% reduction in the interest rate translates to a $178.40 Old interest rate 10.0%
reduction in monthly payment. If the refinance closing costs are New interest rate - 7.5%
$3,000, it will take 16.8 months for the monthly payment savings to Rate reduction 2.5%
total more than the closing costs. Principal amount $100,000
Payment Reduction
One decision which will always have to be made when con- Factor ($/1,000) x 1.784
sidering a rate reduction refinance is how many points to pay. Each Payment reduction $178.40
point is equal to one percent of the new mortgage amount. Table 6- Closing costs 3.0%
2 illustrates such a choice. Months to break even 16.8
The conclusion? In the short term, higher points and a lower

interest rate will cost more. In the long term, the higher the points and the lower the rate, the greater the
savings. In other words, if you are going to have the loan for a long time, finance as many points as is
possible.
95
Chapter 6
Points and Refinance Savings
Closing Total
Costs Months Savings
Interest Including New New to Over 30
Rate Points Points Balance Payment Savings Recover Years
8.25% 3 $4,800 $103,300 $776.06 $138.68 34.61 $49,925
8.50% 2 $3,800 $102,300 $786.60 $128.14 29.66 $46,130
8.75% 1 $2,800 $101,300 $796.93 $117.81 23.77 $42,412
9.00% 0 $1,800 $100,300 $807.04 $107.70 16.71 $38,772
Present Mortgage Balance: $ 98,500 Present Payment: $ 914.74 Closing Costs: Without Points: $ 1,800
Note: Total savings represents the monthly savings over a 30 year period, without taking into account the cost of the refinance. The refinance
cost is not relevant over the term of the mortgage because after 30 years, the mortgage balance will be zero regardless of the alternative
selected. It also does not take into account the increased term of the new mortgage as we are comparing these refinance alternatives to each
other, not to the cost of keeping the original mortgage.
Table 6-2
Effect of Monthly Prepayment on Typical 2. Reduce the term of the mortgage. While
$100,000 Loan at 9%, 30-Year Amortization a straight rate reduction refinance usually will
increase the term of the mortgage, the home
Extra Principal Months Years Total of Interest
Payment & Interest to to Payments Savings
owner may refinance for the purpose of
Payoff Payoff reducing the term of his/her present mortgage
$0 $805 360 30.00 $289.664 $0 in order to save interest payments over the
$20 $825 322 26.79 $265,141 $24,523 life of the mortgage. A term reduction
$50 $855 281 23.42 $240,225 $49,439
refinance will not make economic sense
$75 $880 256 21.36 $225,422 $64,242
unless the new interest rate is lower than the
$100 $905 236 19.70 $213,870 $75,794
$150 $955 206 17.18 $196,769 $92,895
interest rate on the existing mortgage. If the
$200 $1,005 184 15.31 $184,546 $105,118 existing mortgage has a rate which is lower
than market rates, the home owner could
simply increase the amount of existing
Table 6-3 monthly payments in order to reduce the term
of the mortgage, as described by Table 6-3.
Let us take an example of the benefits of a term reduction refinance:

• Original mortgage balance: $100,000
• Original interest rate: 10.5%
• Present mortgage balance: $98,500
• Remaining mortgage term: 336 months
• Present mortgage payment: $914.74
• New interest rate: 8.5%
• New term: 15 years (180 months)
• Closing costs: $1,800
96
• Points: $1,200
• New mortgage balance: $101,500
• New mortgage payment: $999.51
• Remaining payments on
present mortgage: $914.74 x 336 = $307,352.64
• Payments on new
mortgage: $999.51 x 180 = $179,911.80
• Savings through term refinancing:
$307,352.64
(-) $179,911.80
$127,440.84 The home owner saves over $127,000 in interest over the
term of the mortgage!
In the instant case, the homeowner is using the monthly savings from the lower interest rate
towards a reduction in term. If the interest rate reduction is great enough, the applicant can reduce
the term by 10 to 15 years without increasing the monthly payments on the mortgage.
3. Change loan type. It is very common for a home owner to refinance in order to change the loan type
from an adjustable rate mortgage or a balloon program to a fixed rate mortgage. Typically, the home
owner originally opted for these mortgage instruments in order to:
• Qualify at the lower starting rate; or
• Lower the payments during the first few years of the mortgage.
A move may be made to refinance at a time when fixed rates have moved down to an acceptable level
and/or the home owner can qualify for a fixed rate. In the case of a balloon mortgage which has
reached full term, the need may be more urgent. For example, in the sixth year of a seven year balloon
mortgage the home owner may be 12 months or less from facing a balloon payment.
There are other examples of refinances which change the type of loan programs:
• The homeowner may refinance from an adjustable rate mortgage to another adjustable rate
mortgage—taking advantage of the low initial rates in each case:
- Original mortgage: 1998
- One year adjustable: 2% annual cap
- Initial rate: 5%
- 1999 rate: 7%
- 2000 rate: 9% (worst case scenario assumption)
Instead of risking another rate increase in 2001, the borrower refinances into another one year
adjustable:
- 2001 (initial rate): 5%
- 2002 rate: 7%
- 2003 rate: 9% (worst case scenario assumption)
Assuming the closing costs are reasonable, the costs of the refinance will be paid off in less than
one year because of the drop in interest rates from 9.00% to 5.00%.
97
Chapter 6
• The home owner may move from a fixed rate mortgage to an adjustable or balloon instrument if
the drop in interest rates is not enough to warrant refinancing into another fixed rate. The lower
rate on the shorter term instruments may make a refinance worthwhile:
— Present mortgage fixed rate: 9.5%
— Present market fixed rates: 8.5% with 2 points
— Savings will not be attractive to refinance.
— Present three year adjustable rate: 6.00% with 2 points (maximum adjustment
cap of 2%)
• The move from 9.5% to 6.00% will be have a quick pay back (approximately 12 months). After
the pay back of one year, the home owner now enjoys two more years at 6.00% and three more
years at a maximum of 8.00%. This makes sense for a home owner who will be in the property
from two to seven years.
• Sometimes the move to an adjustable rate mortgage makes sense because of long term safety as
well. For example:
— One year adjustable: caps 1% every adjustment and 4% over the life
— Initial starting rate: 6.5%
— Life cap: 10.5%
— Present interest rate: 10.5%
In this case, the life cap of the adjustable is identical to the present rate of the mortgage. The home
owner receives the benefit of the low starting rate and rate changes based upon a short term treasury
security instrument (one year “T”). There is no long term risk of paying a higher rate than presently
because of the low life cap.
• One variation of a refinance to change mortgage programs is a refinance with a primary purpose to
consolidate a present first and second mortgage on the property. It is quite common for second mort-
gages to have terms which are not quite as attractive as first mortgages:
— The rate may be higher;
— The term may be shorter;
— The mortgage may have rate adjustments with little or no cap protection.
4. Take cash out to consolidate debts. A debt consolidation refinance can benefit a home owner by
converting existing debt payments to:
• Lower payments because of the longer loan term; and
• Tax deductible payments because only the mortgage interest is presently deductible.
The following is an example of how a debt consolidation refinance can help the monthly cash flow of
a homeowner:
— Original mortgage balance: $100,000
— Present mortgage balance: $ 98,500
— Present interest rate: 9.5%
— Present monthly principal and interest: $ 840.85
— Present total monthly mortgage payment: $ 1,040
— Present value of the home: $185,000
98
— Present debt structure:

Loan Monthly Payment Balance
Credit cards $250 $ 5,000
Auto loan $500 $15,000
Personal loan $250 $10,000
Personal loan $300 $ 5,000
Totals: $1,300 $35,000
— Present total monthly payments:
$1,040 Mortgage payment
$1,300 Monthly debts
$2,340 Total
— Debt consolidation refinance:
Present mortgage balance $ 98,500
Closing costs + $ 1,800
Points + $ 2,200
Debt pay off + $ 35,000
Total new mortgage balance $137,500
New interest rate 8.5%
New principal and interest
payment $1,057.26
New mortgage payment $1,257
After taxes $900
Present debt payments $2,340
After taxes $2,090
Monthly savings $1,083
After taxes $1,190
The following notations should be made upon analyzing this example:

• The home must have sufficient equity to allow this amount of cash out. In this case the loan-to-value
is 74.32% ($137,500 divided by $185,000).
• Not all mortgage interest via a refinancing is automatically tax deductible. It depends upon the use of
the money and the cash basis of the home.
• Though the monthly payments are reduced almost $1,200 after taxes, it should be noted that a real
drawback of this solution is the spreading out of debt. If the home owner stayed with the original
payments, the non-mortgage liabilities would be paid off in three to five years. Our solution causes the
liabilities to be part of the mortgage which will be paid off in 30 years. If the home owner stays in the
home for 30 years, this disadvantage will be eliminated. If the home owner tries to sell the home two
years later, a huge portion of the equity in the home will be gone. Of course, for home owners who are
having a rough time managing their finances, the benefits of lower monthly payments may outweigh
the cost of home equity loss.
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• There is a second alternative. The homeowner can procure a Opportunity costs of

second mortgage on the present home instead of refinancing refinancing
the whole mortgage debt. Generally, second mortgages carry Present mortgage
balance: $200,000
a higher interest rate than first mortgages (one to two percentage
Present interest rate: 9.0%
points higher) and/or the term of the second mortgages is Costs of refinance: $ 4,000
shorter (five to fifteen years). If present market rates are higher (including points)
than the rate on the existing mortgage, then the second New balance: $214,000
New interest rate: 9.0%
mortgage alternative bears looking into. If the homeowner
Cash back to home
can lower the rate on the first mortgage at the same time as owner: $10,000
accomplishing the debt consolidation, then the first example
makes more sense.
• Procuring a second mortgage also may make more sense when the cash needed is very small com-
pared to the overall size of the first mortgage. For example, if the first mortgage is $200,000 and the
cash needed for debt consolidation is only $10,000, the borrowing costs would be too high for the
procurement of the $10,000 cash unless the new mortgage rate is substantially below the present
mortgage rate--i.e., there is a secondary benefit of rate reduction for the refinancing. In the example
we say that the opportunity costs of borrowing are too high.
In the example, the homeowner only receives the benefit of $10,000 cash because the rate has not
been lowered. The cost for borrowing this $10,000 is $4,000, a full 40% of the cash received!
5. Take cash out for other purposes. Though debt consolidation remains a leading reason why home-
owners remove equity from their home, obviously the homeowner may take cash out for many other
reasons:
• Purchase a vacation property or investment home;
• College education;
• Investment;
• Major purchases;
• Increase tax deductions by having a larger mortgage payment.
The loan-to-value limitations, tax considerations and decision considerations between taking a home
equity second versus a new first mortgage would mirror those discussed in the previous section’s
discussion of debt consolidation refinances.
Mortgage sources and refinancing

When considering a refinance, one of the first decisions a home owner must make will be what
mortgage source to pursue for the refinance. The decision may be based upon:
• The qualifications of the home owner;
• The source of the present mortgage;
• The loan-to-value of the proposed mortgage;
• The purpose of the refinance.
This section will focus upon the industry guidelines for refinances so that the decision process will be
ultimately clearer for someone considering refinance of a home for any reason.
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1. FHA refinances
•
Eligibility. Anyone who presently holds an FHA mortgage can refinance through the FHA
Streamline program38. If the present mortgage is not FHA, then the home owner can refinance
only if the home is owner occupied and the home owner holds no other FHA mortgages.
• The streamline program. The FHA streamline refinance Program is for refinancing existing FHA
mortgages. As long as the new payment is less than the old payment39 and cash back to the
borrower is no more than $250, the documentation required is limited to the following:
— Loan application;
— Previous 12 month mortgage payment history;
— An appraisal40 of the property, if the new mortgage amount finances the closing costs. Prepaids
cannot be financed whether or not an appraisal is provided41;
— No re-qualification of the applicant is required.
If the property is no longer occupied by the applicant,
FHA will allow a streamline refinance if closing costs are not
financed. If the mortgage payment history shows delinquencies FHA streamline MIP
during the previous 12 months, the refinance may have to be $90,000 Mortgage
approved under full documentation processing. $3,000 Closing costs to be financed
$1,350 New MIP (1,50% of base
The FHA ARM program may not be used for a streamline mortgage amount)
refinance of an investor property. If refinancing from a fixed ($1,190) MIP refund from old mortgage
$93,000 Base mortgage amount
rate on an owner occupied property to an FHA ARM, the new $93,160 Mortgage amount including new
interest rate must be at least two percent lower than the rate on MIP ($1,350 - $1,190)
the existing mortgage. If refinancing from an FHA ARM to a
fixed rate, the new rate can increase by two percent over the
current rate.
The mortgage insurance charged for an FHA streamline refinance will be identical to that which is
charged on a purchase transaction (See Chapter 2). However, if the applicant paid one time MIP charges,
the refund will be applied and subtracted from any new insurance premium.42
The applicant should be aware of the fact that the present lender may collect interest until the end of
the month when an FHA mortgage is paid off (whether through a home sale or refinance). Therefore, if
the new FHA mortgage causes the old mortgage to be paid off at the beginning of the month, the applicant
will be charged duplicate interest.
• Full documentation refinances. As long as the home is occupied by the an applicant who holds no
other FHA mortgages, any existing mortgage may be refinanced under FHA mortgage programs
with the following restrictions:
38
If the present owner assumed the mortgage without credit qualification, then they must wait six months before accomplishing a non-
credit qualifying streamline refinance.
39
If refinancing to a shorter term, a $50 increase in payment is allowed.
40
Some lenders might require an appraisal even though FHA does not require such. If closing costs are financed, the 98.75/97.75 LTV
rule applies.
41
The lender can finance prepaids through a higher interest rate, including accrued interest
42
The mip structure which was in place before July 1, 1991 included 3.8% up front for 30 year FHA mortgages on all properties except
condominiums. There was no monthly insurance requirement (except for condominiums).
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— An appraisal, credit report, asset FHA payoff

documentation and income documentation New mortgage funding date .......................... July 7th
must be procured as required on an FHA Present mortgage is paid off ......................... July 9th
purchase. Interest on new mortgage
is collected for ............................................... July 7th
— The maximum mortgage amount cannot through
July 31st
exceed FHA maximum mortgage limits
Interest on present mortgage
published in the local area. is collected for ............................................... July 1st
— The loan-to-value cannot exceed FHA through
July 31st
loan-to-value limitations which exist for
purchases. If paying off a second trust VA full documentation refinance
line of credit, the line must be seasoned at Present mortgage amount: $110,000
least one year. Appraised value of the property: $120,000
— No temporary buydowns are allowed. Closing costs: $2,000
— FHA allows cash out refinances up to 85% Unused entitlement: $25,000
of the value of the property 43 . No Calculation 1:
$120,000 x 75% + $25,000 = $115,000
qualification ratio exceptions are allowed Calculation 2:
for FHA cash out refinances. $120,000 x 90% = $108,000
The maximum mortgage amount is the lower of the two.
— If allowable under the maximum mortgage
amount and loan-to-value calculations, all
closing costs except prepaids may be included in the new mortgage amount. The applicant
cannot pay miscellaneous lender charges such as a tax service fee or underwriting fees.
— Mortgage insurance charged will be identical to the schedule contained for purchase mortgages.
2. VA Refinances
• Eligibility. All eligibility requirements for VA purchases apply: the program is limited to eligible
active military, veterans, reservists and national guard. Any veteran holding an existing VA
mortgage can refinance through the VA fasttrack, or Interest Rate Reduction Refinance (IRRRL)
program. A full documentation VA refinance requires unused entitlement as would be needed for
a VA purchase.
• VA fasttrack refinance. A VA fasttrack refinance is virtually identical to the FHA streamline
refinance. The payment must be reduced unless the term is being shortened, an ARM is being
refinanced or energy improvements are being financed. The documentation required:
— Loan application;
— Previous 12 month mortgage payment history.
— An appraisal is not required, regardless whether the veteran still occupies the property. Closing
costs can be financed regardless of the lack of an appraisal.
The funding fee for rate reduction refinances is 0.5%. This funding fee can always be financed
unless it causes the mortgage to exceed $203,000. If the mortgage payment history shows
delinquencies within the last 12 months, the mortgage may have to be processed under full
documentation guidelines. Otherwise, the veteran does not have to qualify for the new mortgage.
If the current loan is more than 30 days past due, the loan must submitted to VA for preapproval.
43
The 85% is determined from the acquisition cost, or the appraised value plus any allowable closing costs which are paid by the
applicant. If the house was purchased less than one year from the date of refinance, the 85% would be from the acquisition cost, or
original sales price, whichever is lower.
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• VA full documentation refinances. If the present mortgage is not a VA mortgage, it still can be
refinanced under VA full documentation guidelines as long as the veteran occupies the home and
has unused entitlement.
Full documentation refinances, including cash out transactions, are limited to 90% of the appraised
value of the property. VA also allows the financing of the costs energy-efficiency improvements
of up to $6,000. In the example on the previous page, the veteran would not be able to refinance
all the costs as $108,000 does not even cover the existing mortgage amount.
It should be noted that the increases of entitlement from $36,000 to $46,000 in December of 1989
and $46,000 to $50,750 in October of 1994 allowed use of the additional entitlement only for VA
purchases over $144,000 sales price. Because refinances were specifically excluded, any unused
entitlement utilized to effect a refinance transaction must come from a maximum of $36,000.
Other VA restrictions:
— There must be a lien on the property to effect a VA refinance (the property cannot be free and
clear).
— Prepaids can be financed.
— The veteran cannot pay miscellaneous lender charges such as a tax service fee.
3. Conventional refinances
• Eligibility. There are no restrictions on who is eligible for conventional refinances. Fannie Mae
and Freddie Mac allow refinances on second homes and investor properties, though the products
available will be restricted and loan-to-values allowed will be lower than for owner occupied
refinance transactions.
• Streamline refinances. Both Fannie Mae and Freddie Mac have reduced documentation programs
for the refinance of existing mortgages. Here are the parameters:
— No cash out (rate reduction only).
— Original mortgage must have been purchased by Fannie Mae or Freddie Mac. If the original
mortgage was purchased by Fannie Mae (Freddie Mac), the applicant can refinance with the
present servicer of the mortgage under another Fannie Mae (Freddie Mac) program.
— For income documentation only a current pay stub is required. If self-employed, the most
recent tax returns are required. If the original mortgage was originated under a no income
documentation program, then full income documentation and qualification would be required.
— The credit history can be referenced through an in-file credit report, rather than a more in-
depth mortgage credit report. An in-file credit report merely merges credit data from credit
repositories but does not investigate any information contained in the loan application.
— All assets must be verified.
— No appraisal is required if current lender can certify that the value has not declined and the
original appraisal supports the new mortgage amount.
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— The applicant does not have to be re-qualified if the loan is serviced by the originating mortgage
company, original income verified has not declined, there are no mortgage delinquencies for
the past 12 months, and the new payment is within 15% of the old mortgage payment.
— Owner occupied, 1-2 family properties only.
— The new loan can be a fixed rate or balloon mortgage.
• Full documentation conventional refinances. Since there is a multitude of mortgage sources for
conventional mortgages, the possibilities for refinances are actually quite numerous. Here are
some general guidelines which will be found to be true for the majority of conventional refinance
programs.
— Owner occupied no cash out refinances are typically limited to 90% of the value of the appraisal.
Many non-conforming lenders will allow a loan-to-value of 95%.
— Fannie Mae and Freddie Mac presently allow prepaids to be included in the new mortgage
amount. Non-conforming lenders will vary in this regard.
— Cash out refinances are usually restricted to owner occupied refinance transactions, with a
maximum loan-to-value of 70% to 75%. Some non-conforming lenders will allow a loan-to-
value of up to 80%.
— Refinances on second homes typically do not allow cash out and are limited to 80% of the
value of the property. Non-conforming lenders may allow a loan-to-value of up to 90%. The
applicant may not possess more than three other properties which are mortgaged.
— Refinances on investor properties typically do not allow cash out and are limited to 70% of the
value of the property. Non-conforming lenders my allow loan-to-values of up to 80%. The
applicant may not possess more than three other properties which are mortgaged.
— For rate reduction mortgages, if there is presently a second mortgage on the property and this
second mortgage is to be included in the refinance, there may be a seasoning requirement of
one to two years. A seasoning of the second mortgage means that the mortgage has been in
place for a certain period of time. If the second mortgage is an open line of credit, Fannie Mae
and Freddie Mac will consider the mortgage to be in place since the last draw of equity of over
$2,000. For the example in the margin, on January 1, 2000 the line of credit is seasoned for
one and one-half years: July of 1998 until January
of 2000. The draw of $1,000 in 1999 does not count.
Line of credit seasoning
— With the growth of the sub-prime market, many of Home equity line of credit: $50,000
these choices can be expanded with higher market Placed on Property: January, 1995
rates. For example, the sub-prime market might (Used no balance)
offer cash out or investor mortgages to 95% loan- Draw of $10,000: July, 1996
(balance $10,000)
to-value. Draw of $10,000: July, 1997
(balance $20,000)
Draw of $10,000: July, 1998
(balance $30,000)
One can see how a seasoning requirement might be very
Draw of $ 1,000: December, 1999
important for investor refinance programs which do not (balance $31,000)
allow cash to be taken out of the property. For example,
if the home owner has a mortgage of $50,000 and would
like to remove $30,000 cash from his/her investor
104
property, the home owner might place a second trust on the property of $30,000 (perhaps borrowed
from a relative for this short term situation). The home owner then applies to the lender for a no
cash out mortgage of $80,000.
4. State and local bond issues. State and local bond issues exist for the sole purpose of assisting low to
moderate people to purchase their first home. Refinances are not allowed under these mortgage
programs.
Other considerations for refinances

Before embarking upon a refinance transaction, there are some other facts one should note.
1. Right of rescission. The Federal Truth in Lending Law requires a lender to allow a three day right of
rescission for an owner occupied refinance transaction. A right of rescission can be considered a
cooling off period during which the consumer may have a right to cancel the transaction and recover
the costs incurred during the process. Though this law is designed to protect the consumer, one should
be aware of the following drawbacks.
• The three day right of rescission dictates that the lender does not fund the transaction until the
rescission period expires. Therefore, if the mortgage closes on Monday, June 1st:
Monday, June 1st: Closing date
Tuesday, June 2nd: First rescission day
Wednesday, June 3rd: Second rescission day
Thursday, June 4th: Third rescission day
Friday, June 5th: Funding date
This means that the consumer will not receive the money from a cash out refinance and/or the
present mortgage will not be retired before the funding date. This is important to note when the
present mortgage being paid off is an FHA loan. One should remember the fact that the present
lender is entitled to collect interest until the end of the month when an FHA mortgage is paid off.
If the rescission period causes the funding date to move into the next month, the applicant may
end up paying duplicate interest for almost a whole month.
• The mortgage will typically have to fund before the lock period expires. Normally, a mortgage
applicant is given a lock-in for a rate and points which is good for a specified period of days:
60 day lock Lock-in date: July 1 Lock-in expiration date: August 29th
In the above example, a mortgage purchase transaction must close on or before August 29th in
order to preserve the locked-in rate. For a refinance transaction, the mortgage must fund by August
29th, so it must close five or seven days before August 29th. (Sundays and holidays are not
counted as rescission days. In addition, the loan cannot fund on a weekend or bank holiday
because financial institutions are not open for business). Basically, the lender has fewer days to
process the mortgage application for a refinance transaction.
The law provides that the right of rescission may be waived due to an emergency situation.
Unfortunately, the law does not specify what constitutes an emergency and lenders are extremely
reticent to allow the right to be waived under this provision without such guidance. Because the
lender would be in a position to allow the period to be waived, the lender would actually be
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Chapter 6
rendering an opinion that an emergency exists. If the action were later challenged legally, there
would be little or no basis to support that claim because of the lack of specific direction on this
topic in the law. One exception to the rescission period is in the case where the law recognizes no
new financing to be in place. If a refinance is effected through the original lender which is the
present servicer and all closing costs are paid out-of-pocket, a rescission period is not required.
2. Truth-in-Lending. All loans require a truth-in-lending disclosure. Mortgage lending is unique in that
mortgages covered under RESPA, the Real Estate Settlement Procedures Act, require an initial TIL to
be given to the applicant within three days of initial loan application, along with the Good Faith
Estimate of Closing Charges. Refinances have always been exempt from this three day requirement,
though a TIL must be given out sometime in the process and typically this was accomplished at
closing. In 1992, RESPA was amended to require that a Good Faith Estimate be prepared for refinances
within three days of loan application. However, there is still presently no requirement for an initial TIL
disclosure on a refinance transaction.
3. Getting to settlement. When a typical home buyer goes to settlement on a purchase transaction, the
home buyer has plenty of guidance from a real estate professional. The real estate agent typically
guides the home buyer by recommending a settlement agent, insurance company, procuring a pest
inspection on the property and taking care of a host of other settlement requirements. On a refinance
transaction, there is no real estate agent involved. The applicant is literally on his/her own with respect
to bringing the transaction to a settlement conclusion. The guidance of an experienced and diligent
loan officer is essential.
4. Closing costs. One of the most prominent questions facing an applicant when going through a refinance
transaction is:
How much is it going to cost?

Here are highlights of how some of the costs can be different for a refinancing a mortgage as opposed
to a purchase:
• Down payment. Though refinance transactions do not typically require a down payment, the
applicant must make sure that the home appraises for a high enough value to allow the payoff of
the present mortgage balance under the selected mortgage program. Additionally, if the applicant
intends on financing closing costs, the value of the home must be even higher. Keep in mind that
some refinance transactions, typically VA fasttracks, do not require an appraisal to establish the
value. Some lenders may require an appraisal at their discretion.
• Lender charges paid at loan application. The appraisal and credit report charges for a refinance
transaction will typically be no different than those incurred for a purchase. Some refinance programs
require no appraisal and/or credit reports, the most prominent example once again being a VA
fasttrack.
It is more likely that a lender will require a lock-in or application fee for a refinance mortgage
application as opposed to a purchase. On a purchase transaction, the applicant must perform
settlement within a certain time frame as usually specified in the contract. If rates go down after
the mortgage rate is locked-in, what is to keep the applicant from making application and relocking
with another lender on a refinance transaction? In this case, the applicant is just forfeiting the fee
for appraisal and credit report. The lending institution has processed a mortgage without any
106
income generated. The solution: collect good faith money up front from the applicant in the form
of an application or lock fee.
• Lender charges paid at settlement. Origination fees and discount points charged by a lender on a
refinance transaction are not normally any different than purchase mortgages. Some lenders do
charge higher discount points for refinances, especially for during periods of high refinancing
activity. When rates go down, many home owners try to refinance at once, causing log jams with
lenders which may react by trying to slow activity down by raising rates and/or points.
Other lender fees are also going to be identical for purchase and refinance applications. The one
exception will be miscellaneous lender fees on FHA and VA refinances. These are typically paid
for by the seller on FHA and VA purchase transactions. FHA and VA do not allow the lender to
charge such fees at all on refinances, unless the fee is directly to a third party for such services as
document preparation.
One time FHA mortgage insurance and the VA funding fee can be financed on all refinance
transactions, with the exception of a VA refinance which would exceed the $203,000 maximum
VA mortgage amount. VA charges a reduced funding fee of .50% on all fasttrack refinances. FHA
one time mortgage insurance will reflect a reduction by the amount of any refund of present FHA
mortgage insurance if the present mortgage being refinanced is an FHA mortgage which was
subject to one time mortgage insurance.
If the original mortgage had conventional mortgage insurance and the new loan is still above 80%
LTV, the lender may achieve a discount on mortgage insurance by procuring such insurance from
the original mortgage insurance company. This is termed a reissue rate.
• Settlement agent charges. Settlement agents will perform the same services on a purchase or
refinance transaction, hence the charges will be similar. On a purchase transaction, the charges
may be split between the buyer and the seller. On a refinance, the applicant must bear all settlement
charges, including any fee for transmitting a pay off amount to the present lender.
If the home owner already has an owners title insurance policy on the present home, the settlement
agent can typically achieve a reissue rate on the new policy, which may mean a reduction of 25 to
50 percent on the cost of the insurance. If the homeowner possesses a recent survey of the property
(within five years) and no changes have been made within the boundary of the property since the
date of that survey, the lender may accept a survey affidavit from the applicant, eliminating the
cost of a new survey. A survey affidavit is merely a sworn statement attesting to the fact that there
have been no changes. If not, some lenders may accept a recertification of the original survey by
the original surveying company, which may lessen the cost.
• Taxes. Every jurisdiction will differ by their policy concerning taxation of refinance transactions.
Some areas tax refinances as they would a purchase, but the majority have reduced fees. For
example, the recordation fees may be less because a new deed is not being recorded on the
properties. Governments may charge less for owner occupied as opposed to investor refinances.
Others may charge more if the amount of the present mortgage is being increased.
• Miscellaneous fees to complete the appraisal. Most of these fees will not be applicable on a
refinance. For example, a final inspection of a new home is a purchase transaction cost. On the
other hand, if the appraisal dictates that repairs must be completed on the property, the refinance
may incur final inspection charges. Some lenders do not require pest, well and septic inspection
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Chapter 6
reports for refinance transactions. If the refinance is a full documentation FHA or VA mortgage,
then the appraisal issued by the agency will dictate requirements for such.
• Prepaids. Prepaids are payable on a refinance transaction in the same manner as they are on a
purchase. Some mortgage programs do not allow the financing of prepaid charges (for example,
FHA). The portion of prepaids which are placed into escrow with the new lender may very well be
offset by an escrow refund from the present lender. If the applicant is refinancing with the present
lender, then that lender may give a credit for this escrow refund, alleviating the need for money
changing hands.
Though prepaid interest is paid at settlement on a refinance transaction, the home owner should be
made aware of the fact that accrued interest may still be due on the present mortgage since interest
is paid in-arrears. This may seem as though the applicant is paying on both mortgages at the same
time, but a new mortgage payment will not be due for some time after closing, which will cancel
out this extra cost at closing. In effect, a mortgage payment must be made at closing, but the next
payment is skipped. If prepaids can be financed under the program the applicant must decide
whether to finance this interest payment. In the case of FHA mortgages, the present lender has the
right to collect interest to the end of the month when the mortgage is paid off, therefore the home
owner may very well pay duplicate interest during the month of the refinance.
One closing notation. Most lenders will not refinance a property if the intention is to sell the property.
Therefore, if the home is presently or recently was listed for sale, this may present a problem. In addition,
for owner-occupied transactions most lenders require a written statement concerning intent to occupy
after closing.
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Applying and Packaging Your Loan for Approval
7
Applying and Packaging Your Loan
for Approval
There is one secret to the loan application and approval process: preparation. Nothing will delay a
mortgage approval process more than the lack of preparation. Even more significantly, nothing will
reduce an applicant's chances for loan approval more greatly than the lack of preparation. A common
complaint from loan applicants and Realtors is speed of the mortgage approval process and last minute
problems which arise. Yet, it is the unprepared applicant who succeeds in causing many of these delays:
1. Don't push for a quick loan application. Go over the documentation requirements with the loan officer
before the loan application and take the necessary time to procure this documentation so that the loan
officer can review it at the loan application, instead of afterwards.
2. Bring the loan officer everything necessary. Do not hold back on any documentation. Last minute
surprises are often caused by information that surfaced later in the process, information that could
have been gleaned from documentation provided at loan application.
3. Make loan application before offering a sales contract. It makes no sense that the home buyer will
spend weeks looking for a home with or without a Realtor, sign a sales contract, then ask a lender to
process the mortgage in two weeks in order to effect a quick settlement. If the home buyer made loan
application when the home buying process started, there would be many more weeks to iron out
problems. Approval may even be obtained before the home is selected, giving the purchaser more
leverage with the seller.
Preparing the documentation

The next obvious question is:
“If I do need to prepare, then what do I
need to bring to loan application?”
This section will provide a detailed analysis of most every situation which will warrant the provision
of application documentation. Many lenders will provide pre-application packages which will help the
applicant prepare by organizing the necessary information. Note that these requirements may vary widely
by lender and program alternative--many streamline documentation programs now exist.
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Chapter 7
1. The applicant's personal history: The applicant should bring the following personal information to
loan application:
• Living address for the past two years.
• Employment address and phone number for the past two years.
• Social security number (social security card or other proof of social security for FHA mortgages).
• Drivers license or other photo identification for FHA mortgages.
• Address for any rental properties owned by the applicant;
• If the applicant is not a citizen, the green card and/or green card number.
2. Information on the home being purchased or present home (for a refinance).
• Ratified sales contract for purchase.
• Any ratified addenda for purchase.
• Copy of listing data sheet if home was listed by a Realtor.
• If no listing exists, information on yearly property taxes and monthly home owners association
dues.
• Copy of the deed for a refinance.
• If there are any contingencies, or conditions in the contract, the lender will want to see future
addenda removing these contingencies.
• If the contract is amended in any way in the future, the lender must be provided with a copy of all
addenda. New homes will often have increased sales prices with options added after the initial
contract ratification.
3. Information on the applicant's income.
• For those who are employed:
– Pay stubs covering the most recent 30 day period.
– W-2s for the past two years.
• For those who are self-employed:
– Year-to-date profit and loss from the business.
– Previous two years complete Federal individual tax returns (signed).
– Previous two years complete Federal corporate or partnership tax returns (signed) if there is a
corporation or partnership.
• Two years individual tax returns are also needed for those who earn more than 25% of their
income from commission, bonus, or overtime. Any interest or dividend income used to qualify
must also be shown on individual tax returns.
• For those who are using a variable income such as overtime, part-time, commission or bonus—
any information breaking down the types of income for the past two years. This may be the last
pay stub for each year, or a letter from the employer.
• For rental properties, a current one year lease and two years Federal tax returns.
• For note receivable income, a copy of the ratified note and two years tax returns.
• For alimony, child support and/or separate maintenance income, a copy of the separation agreement
and divorce decree or other evidence of support payments and proof of receipt of regular payments
for the previous 12 months.
110
• For social security, retirement, or disability, a copy of the award letter, the letter issued with the
past payment change, and proof of receipt of payments (usually using a 1099, which is the equivalent
of a W-2 for miscellaneous income).
• If there is a raise due in the near future and the increased income is necessary for qualification, the
employer must provide a letter specifying the amount and effective date. The lender may ask to
see a pay stub at the new salary level, either before or after settlement takes place.
4. Information on the applicant's assets.
• For all liquid assets (savings, checking, mutual funds, money market, stocks, etc.) held with a
financial institution, the prior three months statements. The most recent statement will do if these
are issued quarterly instead of monthly. FHA and VA require only two monthly statements.
• For a retirement plan, 401K, or IRAs, the latest statement. Statements covering the previous quarter
are necessary if these assets are to be liquidated in order to purchase the home.
• For the sale of an asset which is going to produce the necessary cash to fund the transaction, a
copy of the agreement and proof of receipt of funds. In the case of the sale of the present home,
the ratified sales contract will be needed at loan application or when received. The settlement
statement (HUD-1) on the previous home may be brought to settlement on the new home if both
settlements are occurring on the same day, or back-to-back.
• If the cash needed is coming from a loan, proof of loan approval must be provided, as well as the
terms of the loan. Later in the process, proof of receipt of funds must be provided.
• If the cash needed is coming from a gift, the lender will provide an acceptable gift letter which
must be filled out by whomever is giving the funds. Most lenders will accept a copy of the donor's
bank statement as evidence of ability to give the gift. The lender also will typically want to see
proof of receipt of funds later in the process.
• If the applicant's employer is paying closing costs before settlement, a copy of the benefits package
or relocation letter must be provided. The lender may want to see receipt of funds later in the
process if these funds are necessary to complete the transaction.
• If the applicant's employer or relocation company is providing an equity advance on the applicant's
present home and the home's sale is guaranteed, provide the terms of the equity advance, proof of
guarantee with minimum sales price, and proof of receipt of funds.
• If the seller is paying closing costs, the terms of such must be specified in the sales contract.
• Always provide a copy of the deposit or escrow check which was used as a deposit on the home
purchased. If not a bank or cashier's check, the lender will typically want a copy of the canceled
check (copy front and back) after it clears the bank account. This ensures that the funds in the
applicant's bank account are in addition to the amount placed upon deposit under the terms of the
sales contract.
5. Information on the applicant's liabilities.
• The balance, monthly payment, account number, and lender address should be provided for all
outstanding liabilities. A copy of the latest statement and/or a page from the payment coupon
book will suffice.
• If the applicant owes child support, alimony or separate maintenance, a copy of the complete
ratified separation agreement and divorce decree or similar evidence.
• For those presently paying rent, the name and address of the landlord.
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Chapter 7
• If the present mortgage is held by a private individual rather than a financial institution or the
present landlord is a private individual rather than a management company, it may be helpful to
provide copies of canceled checks of payments (front and back copied) for the prior 12 months.
• If a home is owned free of liens (is free and clear), the applicant must provide proof that there is no
mortgage on the property. This may include the original settlement sheet, a deed of satisfaction, or
tax returns showing no interest deduction. In addition, proof of the amount of real estate tax,
insurance, and homeowners association payments must be provided.
• If a car is less than four years old and there is no car loan or lease outstanding, the applicant may
be asked to provide a copy of the car title showing no lien.
• If any liabilities are being paid off in order to qualify for this mortgage (unless being paid at
settlement from the funds of a cash out refinance or sale of present home), the lender will want to
see proof of payoff and verify the funds utilized.
• If a relocation in which the applicant's employer is guaranteeing the sale of the present home,
proof that the employer will make the present mortgage payments during any time period in
which the applicant owns two homes.
6. Explanations to provide at loan application. The applicant must provide written explanations for any
of the following situations:
• A gap in employment of more than one month during the previous two years.
• A decrease in income from year-to-year.
• A complex job history (for example, a switch from employed to self-employed and back to
employed again).
• Any bank accounts opened in the previous 90 days, including proof of source of funds.
• Any significant increase in funds in existing accounts during the prior 90 days, including proof of
source of funds. (FHA accepts cash saved at home with documentation of ability to save.)
• Explanation of use of any cash being taken from the property if a cash out refinance transaction.
• Explanation for any late payments of which the applicant is aware. If significant credit blemishes
such as bankruptcies, judgments, etc. have occurred, the applicant should provide documentation
to back up the explanation.
Application
So you have brought two tons of information to the lender. Now What does the loan officer do
with the documents?
what happens? Good loan officers review the information while taking
the loan application. They will be looking for such things as:
1. Pay stubs.
• Does the year-to-date income amount shown match the monthly
salary? For example, if the applicant reports earning $50,000
annually, does the pay stub on June 30th show $25,000 of
income earned for the year? If not, what is the explanation?
One reasonable explanation would be a recent raise to $50,000
salary.
• Are there any regular withdrawals from the pay stub which could be construed as debt payments?
An applicant may have taken a loan from the employer's credit union last year.
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• Does all the personal information match on the pay stub, for example the name and social security
number? Is the pay stub dated within the past 30 days of loan application?
• If there is overtime, bonus, or commission income, is it broken out on the pay stub? Many times
the applicant will report his/her income as salary but a second look at the pay stub will reveal
overtime which will affect the final income calculation.
2. W-2s.
• Are there W-2s for the prior two years? Is the social security number and name correct for each
year? What about the employer's name? Quite often the employer's name or ownership of the
company will change. The employee could have transferred to a different subsidiary from the
same company.
• Does the income match the salary level reported? Minor increases each year would be expected,
but what if the income shown decreased from year-to-year? Can we get a break-out of overtime or
bonus directly from the employer?
3. Tax Returns.
• Once again we would match the personal information: names, social security numbers and dates.
Are the returns signed and are all schedules included? If there is a separate corporation and/or
partnership, are these returns included as well? Watch out for returns which are not current because
of extensions filed. In addition, some corporations are on a fiscal year which will not match up
directly to the calendar years contained in the individual returns. This may affect the final income
calculation or at least the data necessary in order to calculate the final income.
• Does the income on the returns match what is disclosed? For example, if the applicant is a sole
proprietorship (Schedule C), does the bottom line of the Schedule C averaged for two years match
the monthly income disclosed?
• If the applicant is self-employed, is there a profit and loss statement on the business covering the
period from the end of the tax returns to the time of the loan application (or within the most recent
quarter)?
4. Bank statements.
• Is each bank statement complete (all pages) and do you have bank statements current for the past
90 days (there must be three consecutive months)? Is the personal information correct? Watch for
another name on the bank statements which could mean that the account is joint with another
person not involved in the transaction. Does the applicant have permission to use the money, or a
portion of the money?
• The last balance on the most current bank statement is the amount which would be utilized for
calculation of the asset figure. Is this enough to support the transaction, or are they counting on a
deposit recently made (or to be made)? If so, where did the funds for the deposit come from?
• Are there regular withdrawals of the same amount each month which might indicate debts not
disclosed? Large withdrawals and deposits (outside of which the regular pay would support) must
be explained. Any returned checks also must be explained as an item of derogatory credit.
5. Sales contract.
• Is the contract fully ratified (signed) and are all addenda included? Are all purchasers making loan
application? Is the information contained in the sales contract accurate?
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Chapter 7
• If the seller is paying closing costs, are contributions within the program's guidelines? A common
mistake is to specify that the seller will pay prepaids when the program does not allow this. Is the
contract clear on who will pay what points and loan fees?
• Is there personal property conveying which cannot be financed? Perhaps the purchaser is also
buying the furniture in the home.
• Does the listing attached to the sales contract indicate that the home is a condominium or located
in a PUD? If so, is the project approved for the loan program? Does the listing indicate large
acreage which might make the land-to-value ratio too high to support a residential home mortgage?
It is important for the loan officer to procure the answers to any questions concerning loan approval
up-front in the process. For example, if the applicant has been self-employed for only 18 months, is this
acceptable and how is the income to be calculated? With the right information present at loan application
and a proper review of the information by the mortgage representative, the loan officer will be in a
position to pose the question within a few days of loan application.
Processing
What does the mortgage company do with the loan
Loan set-up application?
You have given the mort-
gage company a bundle of
information which has been Sales Submission Submission to
to Underwriter Settlement
reviewed by a loan officer for Contract Sign Off
of Final Conditions
Agent
any questions which may hold
up your loan approval. What
happens now? Submission to
Closing
D
EE
Loan Final
D
Approval Department Settlement
The loan application is Application
then turned over to the pro-

cessing department of the
Securing Approval Preparing
mortgage lender. The pro- Processing Conditions Settlement
Documentation
cessing department is respon-
sible for getting the loan
ready for submission to the underwriting department for final approval. This procedure is called process-
ing the mortgage. Today it is more likely that portions of the processing and underwriting process may
be automated--with appraisals, credit reports and other documentation ordered directly via a laptop by the
loan officer. In this case, we will describe the process as if completed by a separate individual.
The first thing a processor does is set-up the loan. The set-up process consists of the following:
1. Registering the application. Every mortgage lender has a way of keeping track of all mortgage
applications which are brought in by loan officers.
2. Sending the disclosures. The processor must send the Truth-in-Lending Disclosure within three business
days of loan application for all purchase transactions. Typically most other required disclosures are
signed at loan application:
• The Program Disclosure, which describes the mortgage program;
114
• The Transfer of Servicing Disclosure, which describes the mortgage lender's policies and track
record concerning selling the servicing rights of the mortgages the lender originates;
• The Good Faith Estimate of Settlement Costs, which discloses the estimated closing costs;
• The Settlement Cost Booklet, a HUD guide which describes each settlement charge and the
process;
• Consumer Handbook on Adjustable Rate Mortgages, required for ARM applications;
• The Certification and Authorization, which authorizes conventional lenders to investigate your
credit history and reverify any information provided by the applicant (including on no-income
verification mortgages); and,
• The Lock-in Agreement, which will give the mortgage rate terms and conditions.
If the loan application is missing any of these disclosures, the processor sends these with the Truth-in-
Lending. There are also several disclosures which are unique to FHA and VA applications.
Required disclosures for FHA mortgages:
• Important Notice to Homebuyer. Informs the applicant that FHA does not warrant the condition or
the value of the property, warns of the penalties for commission of loan fraud, and states that FHA
does not set the rate and discount points and that these are negotiable with the lender. It also
explains the mortgage insurance costs and the refund process.
• The Lead Paint Disclosure warns about the dangers of lead based paint in homes constructed
before 1978.
• The Assumption Disclosure, which describes FHA policies concerning future assumptions of
FHA mortgages. FHA assumption policies have changed several times in the past, but all presently
originated FHA mortgages need credit approval for assumption and cannot be assumed by investors.
Informs the applicant that he/she must receive a release of liability from FHA in order not to be
responsible for payments after an assumption takes place.
• For Your Protection: Get a Home Inspection. Inform buyers that an FHA appraisal is not a home
inspection and advise them that an inspection is recommended.
• Informed Comsumer Choice Disclosure Notice. Compares the cost of an FHA Mortgage to
Conventional alternatives, including the costs of Mortgage Insurance.
• Notice to Homebuyer (Homebuyer Summary). Provided by the FHA appraiser indicating whether
the home meets minimum FHA minimum property standards.
Required disclosures for VA mortgages:
• The Interest Rate and Discount Disclosure Statement states that the rate and points are not set by
VA and are negotiable with the lender.
• The Verification of VA Benefit Related Indebtedness (VA Indebtedness Letter) enables the lender
to verify from VA that the applicant/veteran does not have any unpaid or unscheduled indebtedness
to the agency. Also gives VA an opportunity to indicate that the applicant/veteran is exempt from
the funding fee due to receipt of VA disability
• The Federal Collection Policy Notice informs the applicant/veteran of actions the government can
take if scheduled payments are not made.
• Assumption of VA Guaranteed Mortgages discloses VA's policy with regard to assumption of
mortgages made after March 1, 1988. This includes credit approval, payment of 1/2 point VA
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Chapter 7
funding fee, a lender processing charge, and assumption of liability by the person assuming the
mortgage.
• For homes built before 1978--Notice of Possible Lead Based Paint and/or Lead Based Paint
Hazards (VA Form 26-6705e) which includes a 10 day opportunity to conduct an evaluation.
• The VA Debt Questionnaire asks the veteran about past foreclosure or judgment problems. Also
asks the veteran about present delinquencies or defaults on Federal obligations.
• Counseling Checklist for Military Homeowners. Active duty borrowers must sign to certify that
they have received homeownership and loan obligation counseling.
3. Ordering the credit report and appraisal. The processor orders the credit report and appraisal from
vendors selected by the mortgage company. The appraiser selected may be an employee of the lender
(a staff appraiser), an independent company selected by the lender, or selected by FHA or VA from
their panel of approved appraisers.
When ordering the appraisal, it is important to indicate:
• The type of transaction. For example, if the application is for an investor transaction an operating
income statement and comparable rental schedule will have to be ordered with the appraisal.
• The type of property. For newer condominiums, special forms may have to be ordered which
describe the complex and ownership. For 2-4 unit properties, operating income statements will
have to be ordered.
• The approval status of condominium and PUDs. If a certain planned unit development is not
approved by FHA, then the appraisal request will be rejected.
The credit report may be ordered directly on -line and if there is a separate corporation or partnership,
the lender may require a business credit report on that entity. The requirement for a business credit
report is less likely since Fannie Mae halted this practice a few years ago.
4. Ordering verification forms. The vast majority of mortgage programs will now accept the documentation
brought to the lender by the applicant as the final income and asset documentation needed for loan
approval. Use of W-2s, pay subs, and bank statements is called alternative documentation. A full
documentation loan would consist of verification forms sent to the employers and banks:
• A Verification of Employment, is sent to current and former
employers for the past two years;
• A Verification of Deposit, is sent to all banks where liquid What happens after the
assets are held; processor “sets-up” the
loan application?
• A Verification of Mortgage or Rent, is sent to the present
landlord or mortgage holder.
Almost all lenders now accept alternative documentation in lieu
of sending out these verification forms. The processor will be
required to verify the employment of the applicant via the telephone
with the employer for a measure of independent verification of the
information contained in alternative documentation.
Processor Review
The processor then waits for the credit report, appraisal, and veri-
fications to arrive. Also to be arriving from the applicant will be a list
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of information missing at loan application. For example, perhaps a profit and loss was not prepared for a
self-employed applicant. What does the processor review these documents for?
1 Credit report review. A credit report is reviewed for the following:
• Verification that all personal information such as the social security number is correct. The wrong
social security number could cause some or all of the data to be incorrect.
• Verify that all disclosed debts are present and the payment and balances are accurate. If payments
are higher than what was disclosed at loan application, the applicant must be re-qualified.
• Verify that any undisclosed debts are not present. If there are any significant undisclosed debts,
the applicant must write a letter as to why they were not disclosed and must be re-qualified with
the extra payments.
• Look for any late payments, judgments, tax liens, bankruptcies, or collections. Any significant
late payments will require a letter from the applicant. Significant credit blemishes (for example a
tax lien) may also require back up documentation to accompany the explanation. Any outstanding
bad debts must be satisfied--such as unsatisfied judgements.
2. Appraisal review. An appraisal is reviewed for the following:
• Verification that property information is correct—address, legal description, etc.
• Verification that the property has appraised for at least the sales price or minimum value necessary
to effect the refinance transaction.
• Verification that the appraiser did not specify any conditions, for example repairs to be completed
before settlement.
• Verification that there is no negative information contained in the appraisal. Negative information
might include poor condition of the property, declining property values, above the value range for
the area, exceedingly high land-to-value, etc.
• Make sure the comparables selected are adequate: recent, closed and that the adjustments made
for size, condition, location options and rooms are reasonable.
• Make sure that additional forms required, such as an operating income statement and comparable
rental schedule for investor transactions, are included.
3. Verification review. If full documentation, the verifications of employment, deposit, mortgage and
rent are reviewed for:
• Are the forms signed and dated by the proper authority? No cross-outs or white-out are allowed
which are not initialed.
• Does the information on the verification match the information on the loan application, including:
– employment dates and salary information.
– bank account value.
– monthly payments and balance.
• Is there any information which will have to be explained such as:
– Increases in the balance of bank accounts.
– Undisclosed debts such as open credit lines on these accounts.
– Recently opened debts or bank accounts.
– Late payments.
– Poor probability of continued employment.
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Chapter 7
– Gaps in employment dates.

– Decrease in salary.
After the information is all received and reviewed

What does an underwriter
After all information has been received and reviewed by the
do with a loan application
processor or loan officer and any discrepancies have been explained,
submission?
the loan application is then worked-up to be submitted to the under-
writer for final approval. Work-up consists of producing the final loan application (which typically is
signed at settlement), preparing a transmittal form, and putting all documents in final submission order.
Underwriting
If one has ever communicated with a mortgage company after a mortgage application was submitted
to the underwriting department, one would think that there is some closed room where no one dared to
enter until a magical process was completed. The truth is, there is no magic or mystery to the underwriting
process. If the loan is packaged the way we described in this Chapter and any questions concerning
discrepancies such as the acceptability of high ratios were asked up front, then the underwriting process
should be quite rote. If the loan package is packaged poorly with no explanations and missing documen-
tation, then we will hear the dreaded words:
“There are some last minute conditions
the underwriter wants to see before making
a decision. I don't think that we will close
as scheduled this Thursday”
What last minute conditions? Here are a few of the typical conditions:
• Explain the source of funds for the down payment, focusing on the large deposit in the borrower's
account last month.
• Back up documentation is needed to support borrower's explanation of a car accident and hospital
bills which caused the late payments.
• The separation agreement shows a joint property owned by the applicant and his ex-spouse. Show
proof of disposition of the property, proof that the spouse is making payments since that time, or
verify and add the mortgage to the debt ratio.
• The appraisal's value is higher than the predominant value range for the neighborhood. Have the
appraiser explain why the home is not an over improvement.
• The tax returns show a limited partnership with losses of $5,000 each year. Provide K-1's to show that
the applicant does not own over 25% of the partnership and does not contribute significant capital
each year.
This is all documentation which should have been provided to the underwriter before underwriting. If
the underwriter has a complete package, then the process is simply a check to make sure that the loan does
not exceed limits for the program:
• Is the loan-to-value correct for the property type and transaction?
118
• Is there any excess seller contributions?

• Are the ratios within acceptable guidelines, or are there compensating factors present to allow higher
ratios (supported by a cover letter from the originator)?
If the underwriter sees a complete package which is well documented and explained, the loan will be
returned with an approval and the conditions assigned will be standard settlement conditions such as:
• Pest inspection report;
• Survey;
• Final truth-in-lending disclosure;
• Title commitment, or binder, from settlement agent;
• Homeowners insurance policy;
• Rate lock-in, if floating;
• Seller contributions to match those in contract;
• Three day right of rescission for refinances.
Either the processing or closing department will procure these final conditions in order for settlement
to occur. Most mortgage lenders require that the final settlement conditions be received at least 48 to 72
hours before settlement is to occur.
The key to the whole process is the provision of documents up front. A mortgage application can take
a few minutes to achieve approval, or three months. The greatest variable is the way documentation is
provided, examined and explained.
Automated Underwriting
Automated underwriting has significantly altered the way the loan application process proceeds. With
complete information, a loan officer can enter the data on a laptop, order a credit report and have the loan
decision within minutes. This is especially helpful if the applicant has not purchased a home as of yet and
wants a "pre-approval" before making an offer on a house. If the credit score is low, it is likely the loan
may come back as requiring a closer review by an underwriter--and the process will more than likely
resemble the description of the previous pages. These systems allow the underwriters to spend their time
with the files that need the closest review. For those with good credit histories, income and assets-- much
of documentation required by the lender can be eliminated or at least lessened. For example, why request
a copy of a deposit check when there are more than enough liquid assets to close the loan?
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Chapter 7
ITEMS NEEDED FOR LO AN APPLICA

LOAN TION
APPLICATION
1. Fully ratified sales contract and addenda.

2. Most recent original paystubs, covering a 30 day
period.
3. Original W-2s for past two years.
4. For self employed and commissioned only. Two
most recent years complete, ratified federal
individual and corporate tax returns. Year-to-date
profit and loss dated within 90 days.
5. One year lease and tax returns for all investment
properties.
6. Proof of any additional income needed to qualify.
7. Gift letter and proof of donor’s ability to give.
8. Original bank statements (all pages) covering most
recent three month period.
9. Child care statement (VA loans), divorce decree,
separation agreement.
10. List of all debts owed, account numbers, balances
and monthly payments. Copy of payment books or
statements for these loans.
11. Name, address and phone number of current
landlord (if renting). Copy of listing, lease and/or
sales contract for present home (if own).
12. Copy of car title if auto is owned free and clear and
less than five years old.
13. Social security card and picture ID (FHA Loans).
14. DD-214 and Certificate of Eligibility (VA Loans).
15. Check for application fee.
Table 7-1
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Mortgages, Home Ownership and Taxes
Mortgages, Home Ownership and

Taxes
We began this book by indicating that one of the main economic motivations behind the ownership of
real estate is the tax advantages. We end the book by summarizing the implications of real estate holdings
upon one's obligation to pay taxes. This Chapter should by no means serve as a replacement for qualified
advice from a tax professional. Tax laws and interpretations thereof change on a periodic basis and the
information we are presenting is accurate to our knowledge only as of the date of printing. On the other
hand, we cannot imagine someone learning about real estate without wanting an overview of the topic's
implication regarding taxation.
Purchasing a Home
When one purchases a home, will any or all of the costs paid at settlement affect tax obligations? This
has long been a gray area of tax law, especially with regard to the deductibility of points paid by the
purchaser. IRS has indicated that:
• Points computed as a percentage of the loan are tax deductible by the borrower in full for the tax
year in which the points were paid. This is true for owner-occupied purchase transactions only.
For refinances, the points must be deducted over the life of the mortgage except the portion of the
proceeds utilized for home improvements.44
• The purchaser does not have to write a separate check at settlement for the points in order for them
to be deductible.
• Any points paid by the seller can be deducted by the purchaser but will reduce the cost basis of the
home. This will affect the calculation of a gain when the home is sold.
• The amount of points must conform to established business practice of charging points for loans
in the area in which the property is located.
• The points cannot be paid by the lender (lender closing cost credit).
44
The U.S. Court of Appeals for the Eighth Circuit has allowed the full deduction in the year paid for points on a long-term home mortgage
loan refinancing a short-term balloon loan used to acquire a home.
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Chapter 8
Of the additional costs paid at home purchase the following are deductible:
• Prepaid Interest. Any interest paid to the lender at settlement would be deductible. This will be
expanded upon later in this Chapter;
• Real Estate Property Taxes. Any real estate property taxes paid by the borrower during the purchase
of the home will be deductible, but only after money is actually paid to the taxing authority:
Example: Settlement Date: November 30, 1999

Tax Escrow: Six Months @ $150 ($900)
Tax Payment Due: July 1, 2000 (12 months)
The above tax escrow would not be paid out by the lender until 2000, and therefore is not deductible
in 1999.
The following costs paid at home purchase are not deductible:
· Insurance. Hazard, homeowners, mortgage, flood, and title insurance are not deductible;
· Taxes. Recordation taxes, recording fees and transfer taxes are not deductible;
· Services. Fees for services such as attorney fees, survey preparation, pest inspection report, appraisal
and underwriting fees are not deductible.
Does this suggest that a borrower who is paying a lender for a $300 underwriting fee actually ask the
lender to charge a proportional higher amount of points rather than the underwriting fee? Sounds like this
would be a winning tax reduction strategy—as long as it can be argued that it is within established
business practices.
Just because a particular cost is not deductible at settlement does not mean that it will not factor into
the tax equation at a later date. It is important to keep copious records of the purchase transaction and we
will explain why in the section covering the home sale.
Deduction of Regular Mortgage Payments

A typical mortgage payment consists of the following components:
• Principal;
• Interest;
• Real Estate Taxes;
• Insurance;
• Homeowners;
• Mortgage Insurance;
• Homeowners Association Fees.
Deductible Portion Non-Deductible Portion

Mortgage Interest Insurance
Real Estate Taxes Homeowners or Condominium Association Fees
(except portion which goes to pay real estate taxes)
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Mortgage Interest Deductions. As Congress has lowered the tax rates, many tax deductions have
been eliminated. Mortgage interest has stood the test of time as a deduction but it has not remained
unscathed:
Interest on mortgages made before October 13, 1987 is fully deductible as an itemized deduction. For
mortgages made after that date, we have two classification of mortgages:
· Acquisition Debt: A mortgage secured by a primary residence or second home which is incurred
when you buy, build or substantially improve your home. This is deductible to a limit of $1,000,000
($500,000 if married and filing separate returns). The acquisition of the home must be made
within 90 days before or after incurring the mortgage.
· Home-Equity Debt. A mortgage secured by a primary residence or second home which is incurred
after home purchase. The maximum amount of deductible home-equity debt is $100,000, however
the acquisition debt and the home-equity debt cannot exceed the fair market value of the residence at
the time of incurring the home-equity debt. This is important because there have been offered home
equity loans on the market which have exceeded the fair market value of the home (125% loans).
In the case of a second trust, the calculation of home-equity debt is easy: The full amount of the
second trust is home-equity debt and is deductible up to $100,000. In the case of a refinance:
$300,000 Sales Price
$250,000 Original Mortgage
$245,000 Principal Balance at Time of Refinance
$500,000 Value at Refinance
$300,000 Mortgage at Refinance
The new first trust would have $245,000 of acquisition debt and $55,000 of home-equity debt,
both of which would be deductible.
· Home Construction Loans are fully deductible as acquisition debt from the time construction
begins to a period of up to 24 months or 90 days after the construction is completed, whichever
comes first.
· Home Improvement Loans secured by the property can be added to the original acquisition debt
(up to $1,000,000) because they add to the value of the home. This does not include loans made
for the purpose of funding maintenance repairs.
· Second Home Residences qualify if used for personal (non-rental) purposes for the greater of 14
days or 10% of the rental days per year.
· Cooperatives qualify for the home mortgage interest deduction even though the shareholders do
not own their apartments. The IRS considers indebtedness secured by stock in the cooperative
deductible as long as it is occupied as the primary or secondary residence.
Mortgage interest as an itemized deduction is subject to an overall floor on itemized deductions that is
applied to higher income taxpayers. This floor is indexed annually to the inflation rate.
Real Estate Property Tax Deductions. Real estate property taxes are deductible on the date paid by
the home owner or the lender on behalf of the applicant in the case of a lender-held escrow account. This
is important to note because the date the home owner pays into the escrow account for property taxes is
not relevant. The date that the lender pays the governmental authority is relevant.
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Chapter 8
In the case of a condominium association, the portion of the condominium association fee which is
allocated for real estate property taxes on the common areas is also deductible. In the same manner, tenant-
stockholders of cooperative apartments may deduct a proportion of the taxes paid by the cooperative.
Example: $100 Monthly Condominium Association Fee
$100,000 Annual Condominium Association Budget
$5,000 Annual Condominium Association Property Taxes
(equals 5% of budget for property taxes)
$100 x 5% x 12 = $60 of annual fees are tax deductible
Tax Deductions and Refinances

We have already touched upon the deduction of mortgage interest after a refinance takes place. What
about the costs of a refinance — are they deductible? Basically, the costs outside of interest and taxes paid
are not deductible. Points paid in conjunction with a refinancing can be deducted, but must be deducted
over the life of the mortgage unless the purpose of the refinance was to pay off a short term or bridge loan
on the property. If you sell your home before the points are fully written off, then the residual value may
be written off when calculating the final gain on the sale.
There has been much controversy with regard to the IRS position with regard to the deductibility of
points paid on refinance transactions. Some have taken the position that refinances for the purpose of
home improvements can be treated as purchases with regard to this issue. Others have taken the position
that points which are financed by rolling in the costs into the new mortgage are never deductible. In other
words, the borrower must pay refinance loan points "out of pocket.”
Rental Property Deductions

The cash flow loss on a rental property is fully deductible on an individual's tax returns as long as the
individual is actively involved in the management of that property, the losses do not exceed $25,000 each
year, and the adjusted gross income of the individual does not exceed $100,000. The allowable deduction
is phased out between $100,000 and $150,000 annual adjusted gross income.
Example of Schedule E Rental Loss:
$12,000 Annual Rental Income
$ 5,000 Mortgage Interest
$ 2,000 Real Estate Taxes
$ 500 Advertising
$ 1,000 Insurance
$ 1,800 Homeowners Association Fees
$ 1,500 Maintenance
$ 2,500 Repairs—Painting and Electrical
$ 300 Travel
$ 3,000 Depreciation
$17,600 Total Expenses
( 5,600) Rental Loss
124
Depreciation for real estate placed into service after December 31, 1986 is 27.5 years for residential
rental property. The method of depreciation is the "straight-line method,” which means that an equal
amount of depreciation is taken each year. “ACRS” depreciation methods previously allowed acceler-
ated depreciation of a property over a smaller number of years, which increased the yearly deductions for
a rental property. It should be noted that any depreciation will have to be recaptured upon sale of the
property—and the gain is taxable. That is, the calculation of gain would increase by the amount of any
real property depreciation previously taken on the property.
Taxation Upon Sale of Residential Real Estate

The sale of real estate can result in a capital gain just as the sale of any assets such as stocks and bonds.
Unlike other assets, the sale of your primary residence receives significant preferential tax treatment:
The Taxpayer Relief Act of 1997 eliminated the rule which required homeowners to roll-over home
sale gains until they were able to take a one time exclusion over the age of 55. In its place the profits of
the sale of a principal residence are excluded from income up to a maximum of $500,000 for married
couples and $250,000 for individuals. This rule applies to home sales after May 7, 1997 and you must
have owned the home at least two years and used it as your primary residence at least two out of the past
five years. Even those who have already taken the one-time exclusion before this date can participate as
long as they meet the principal residence test. The only exception to the "two-years-out-of-five" standard
is if a sale was necessitated by a change in place of employment, health or unforeseen circumstance. In
this case, the IRS will allow a percentage of the exclusion based upon how long the property was owned
and used. Gains on the portion of the property used for business purposes (such as a home office) cannot
be excluded.
Gains above the $250,000 or $500,000 exclusionary amounts are taxed at a long term capital gains
rate of 20% (maximum tax bracket). There is a 10% capital gains rate for those in a 15% tax bracket. An
18% capital gains rate would apply to those who sell homes occupied as primary residences for at least
five years and sold beginning in the year 2001 (8% for those in the 15% tax bracket). Sales of homes
utilized for investment purposes would also be subject to long term capital gain rates. There is no provi-
sion which allows one to take a capital loss if the sale of a home results in a loss.
How is the gain of a home calculated? The following is the formula and a sample calculation:
Selling Price: $100,000
Less:
Selling Expenses: $ 8,000
Fix-up Expenses: $ 2,000
Cost of Home: $ 40,000
Cost of Purchase: $ 5,000
Cost of Improvements: $ 20,000
Total Deductions: $ 75,000
Total Gain: $ 25,000
125
Chapter 8
Let's take a brief definition of each of these deductions:

• Selling Expenses are the costs a seller incurs upon sale, for example the sales commission to a real
estate agent, transfer taxes, and closing costs paid on behalf of the purchaser.
• Fix-Up Expenses are the costs incurred to ready the house for home sale. The expenses must be
incurred within the period 90 days before and 30 days after the sales contract is ratified (for
owner-occupied properties).
• The Cost of the Home is the purchase price which should be supported by a HUD-1 and the
original sales contract.
• The Costs of Purchase are the closing costs which were not deductible as itemized deductions in
previous years. These may include transfer taxes, attorney fees, appraisal fees, survey, etc. They
do not include regular expenses such as home owners association fees and homeowners insurance.
• The Costs of Improvements are the capital improvements made to the home after purchase and
before the sale. The types of improvements are those which would increase the value of the home,
but are not for repair of items already located in the home. For example, replacement of a water
heater would be a repair. The installation of a deck in a home which did not previously have a
deck, would be considered an improvement. Replacement of an old deck with a newer, bigger
deck, would be considered both a repair and an improvement. The IRS publishes a list which
delineates acceptable improvements on the outside and inside the home. A few examples of
inclusions:
Shrubs Driveway
Dishwasher Additional Acreage
Bathtub Sprinkler System
Air Conditioning Finish Basement
Intercom Built-in Furniture
A few notes on two types of real estate transactions which will differ from the IRS taxation treatment
described above:
• Sale of Rental Property. The sale of rental property is not eligible for the same income tax breaks
as the sale of a primary residence. There is no possibility of rolling over the gain and no exclusion.
In addition, any depreciation of the rental property must be recaptured upon the sale of the home.
Recapturing refers to subtracting all real property depreciation from the original purchase price
when figuring the gain on the sale. In other words, the gain will be increased by the amount of
depreciation taken. The tax rate on the portion of the gain resulting from recapture of depreciation
is 25%.
There is one way to avoid tax on the sale of a rental property. A tax-free, like-kind or Starker
exchange involves the sale of a property used for income producing purpose and the purchase of
another rental property of equal value at the same time. In this way, the gain is not realized for tax
purposes until the second property is sold. In September of 2000, the IRS issued new rules that
allowed the purchase of the new property before the present property is sold (Reverse Starker
Exchange) as long as it was held in a "qualified exchange accommodation arrangement," or QEAA.
• State Bond Issues. The sale of property purchased under a state or local bond issue program may
be subject to a recapture tax. Purchasers may be subject to this tax if the home is disposed of in
126
less than ten years from purchase and the income of the purchaser at the time of sale exceeds the
maximum gross income limits for the program in effect at the time of purchase. The maximum
gross income is adjusted upward to include tax exempt interest and downward to include the gain
on the sale.
Each program publishes a formula which calculates the maximum amount of tax. For example,
original loan amount multiplied by 6.25%, reduced by a percentage which is determined by the
holding period. The home owner would pay 100% of this tax if the adjusted gross income is
exceeded by $5,000 or more. If the adjusted gross income is exceeded by $1,000, then 20% of the
tax would be paid.
Example:
Original Mortgage Amount: $100,000
Times 6.25%: $ 6,250
Held for 6 years (60% of tax): $ 3,750
Exceeds the income limits
by $3,000 (60% of above): $ 2,250
Special IRA Provision
The Taxpayer Relief Act of 1997 contained a special provision with regard to the purchase of a first
home. Withdrawals can be made penalty free up to $10,000 for the purpose of purchasing a home. A
first-time homebuyer is defined to include someone who has not owned a home within the past two years.
Though the homebuyer would be exempt from the 10% penalty, they would not be exempt from paying
regular income taxes on the money withdrawn—unless the money came from a Roth IRA and was taxed
in the year the contributions were made.
127
Appendix A Interest Rate Factors
Interest Rate Factors

Interest Interest
Rate 30 Yrs 20 Yrs 15 Yrs Rate 30 Yrs 20 Yrs 15 Yrs
2.50 3.95 5.30 6.67 7.50 6.99 8.06 9.27
2.625 4.02 5.36 6.73 7.625 7.08 8.13 9.34
2.75 4.08 5.42 6.79 7.75 7.16 8.21 9.41
2.875 4.15 5.48 6.85 7.875 7.25 8.29 9.48
3.00 4.22 5.55 6.91 8.00 7.34 8.36 9.56
3.125 4.28 5.61 6.97 8.125 7.42 8.44 9.63
3.25 4.35 5.67 7.03 8.25 7.51 8.52 9.70
3.75 4.42 5.74 7.09 8.375 7.60 8.60 9.77
3.50 4.49 5.80 7.15 8.50 7.69 8.68 9.85
3.625 4.56 5.86 7.21 8.625 7.78 8.76 9.92
3.75 4.63 5.93 7.27 8.75 7.87 8.84 9.99
3.875 4.70 5.99 7.33 8.75 7.96 8.92 10.07
4.00 4.77 6.06 7.40 9.00 8.05 9.00 10.14
4.125 4.85 6.13 7.46 9.125 8.14 9.08 10.22
4.25 4.92 6.19 7.52 9.25 8.23 9.16 10.29
4.375 4.99 6.26 7.59 9.375 8.32 9.24 10.37
4.50 5.07 6.33 7.65 9.50 8.41 9.32 10.44
4.625 5.14 6.39 7.71 9.625 8.50 9.40 10.52
4.75 5.22 6.46 7.78 9.75 8.59 9.49 10.59
4.875 5.29 6.53 7.84 9.875 8.68 9.57 10.67
5.00 5.37 6.60 7.91 10.00 8.78 9.65 10.75
5.125 5.44 6.67 7.97 10.125 8.87 9.73 10.82
5.25 5.52 6.74 8.04 10.25 8.96 9.82 10.90
5.375 5.60 6.81 8.10 10.375 9.05 9.90 10.98
5.50 5.68 6.88 8.17 10.50 9.15 9.98 11.05
5.625 5.76 6.95 8.24 10.625 9.24 10.07 11.13
5.75 5.84 7.02 8.30 10.75 9.33 10.15 11.21
5.875 5.92 7.09 8.37 10.875 9.43 10.24 11.29
6.00 6.00 7.16 8.44 11.00 9.52 10.32 11.37
6.125 6.08 7.24 8.51 11.125 9.62 10.41 11.44
6.25 6.16 7.31 8.57 11.25 9.71 10.49 11.52
6.375 6.24 7.38 8.64 11.375 9.81 10.58 11.60
6.50 6.32 7.46 8.71 11.50 9.90 10.66 11.68
6.625 6.40 7.53 8.78 11.625 10.00 10.75 11.76
6.75 6.49 7.60 8.85 11.75 10.09 10.84 11.84
6.875 6.57 7.68 8.92 11.875 10.19 10.92 11.92
7.00 6.65 7.75 8.99 12.00 10.29 11.01 12.00
7.125 6.74 7.83 9.06 12.125 10.38 11.10 12.08
7.25 6.82 7.90 9.13 12.25 10.48 11.19 12.16
7.375 6.91 7.98 9.20 12.375 10.58 11.27 12.24
The above factors represent the monthly payment per thousand. To arrive at a monthly mortgage payment,
multiply the mortgage amount in thousands by the factor. It should be noted that these factors represent
approximations of the precise monthly payment.
Example: 1,000 Mortgage 7.69 Factor
30 Year x 100 Mortgage Amount
8.50 Interest Rate $769.00 Monthly Payment
A-1
Appendix A Interest Rate Factors
A-2
Appendix B Federal Withholding Tax Tables
B-1
$5,040 and over use 28% of excess over $5,040 up to $5,183; in excess of $5,183 use, 36% to $11,533; in
excess of $11,533, use 36% to $24,917. Above $24,917 the tax rate is 39.6%.
B-2
B-3
$5,840 and over use 28% of excess over $5,840 up to $8,767. Use 31% of excess over $8,767 up to $14,267
and 36% for excess over $14,267 up to $25,171. Over $25,171, the tax rate is 39.6%.
B-4
Appendix C Estimate of Settlement Costs of A Mortgage Transaction
ESTIMA TE OF SETTLEMENT COSTS OF

ESTIMATE
A MOR TGA
MORTGA GE TRANSA
TGAGE CTION
TRANSACTION
A. ITEMS PAID FOR AT LOAN APPLICATION:

1. APPRAISAL ................................................................................................................. _______
Conventional/FHA/VA $250 - $375
NOTE: Add $75-125 for 2-4 unit or investor property. Homes over $500,000 may be more.
2. CREDIT REPORT ......................................................................................................... _______

$45-65
NOTE: Extra report non-married coborrowers. If lender uses an "in-file" charge may be less.
3. APPLICATION/LOCK FEE ........................................................................................... _______

.25-1.00%
of Loan Amt
NOTE: If charged, may be applied to closing costs at settlement. If so, do not add in total
SUBTOTAL ......................................................................................................................... _______
B. PREPAID ITEMS
1. ONE YEARS HOMEOWNERS INSURANCE ................................................................ _______
(First Year Premium) $2.00 to $3.00 per
$1,000 Loan Amt
NOTE: Paid Directly by Applicant (may be credit if refinance)
2. PRIVATE MORTGAGE INSURANCE ........................................................................... _______

(First Year Premium) .25% to 1.20%
of Loan Amt
NOTE: Applicable over 80% LTV conventional mortgages. Varies by loan type, LTV, and Company
3. ESCROWS
NOTE: On refinances, escrow account will be refunded by present lender
3A. REAL ESTATE TAXES ........................................................................................ _______

3 to 14 Months
NOTE: Will be higher in states collecting only one time each year
3B. HOMEOWNERS INSURANCE .............................................................................. _______

2 Months
NOTE: From annual estimate above
3C. MORTGAGE INSURANCE .................................................................................... _______

(Monthly Premium) 2 Months
NOTE: .20% to 1.04% monthly conventional over 80% LTV depending upon loan type, LTV and
company. May eliminate the need for first year premium (above). .
50% for FHA loans (.25% 15 year FHA)--up-front premium is financed.
4. PREPAID INTEREST ................................................................................................... _______

Estimate 15 Days
NOTE: Will vary in accordance with settlement date
SUBTOTAL ......................................................................................................................... _______
C-1
C. LENDER CHARGES
1. LOAN ORIGINATION FEE ........................................................................................... _______
Up to 1%
of Loan Amt
NOTE: Figured on base loan amount for FHA, including funding fee for VA
2. DISCOUNT POINTS ..................................................................................................... _______

Varies
NOTE: Each discount point is one percent of the loan amount including funding fee or FHA MIP
3. DOCUMENT PREPARATION/REVIEW OR CLOSING FEE ........................................ _______

$150-$350
4. LENDER INSPECTION/COURIER FEES ..................................................................... _______
$50-$125
5. TAX SERVICE FEE ..................................................................................................... _______
$50-100
NOTE: 3-5 Above cannot be paid by applicant on FHA/VA loans except if paying for 3rd party service.
Cannot be charged on FHA/VA refinances except for 3rd party services.
6. VA FUNDING FEE ........................................................................................................ _______

If Not Financed
NOTE: 2.00% for no downpayment purchases and refinances. 1.50% for 5% down purchases and
1.25% for 10% down purchases and .50% for all VA rate reduction refinances. Can always be financed
except if loan amount would exceed $203,000. Higher for second time users and reservists.
7. FHA MORTGAGE INSURANCE ................................................................................... _______

If Not Financed
NOTE: 1.50% for all loans except condominiums. Can always be financed
SUBTOTAL ......................................................................................................................... _______
D. ATTORNEY CHARGES
1. ATTORNEY FEES: ...................................................................................................... _______
$100-$500
NOTE: May be separate charge to seller. Includes preparation of documents, title exam, courier
charges, payoff fees.
2. SURVEY ....................................................................................................................... _______

$150-$400
3. TITLE INSURANCE:
3A. OWNERS POLICY: Based upon sales price (optional) ........................................ _______
$350-$700/$1,000
NOTE: Owner policy includes lender policy below:
3B. LENDER POLICY: Based upon loan amount (mandatory) ................................... _______
$250-$600/$1,000
NOTE: May be additional charges for endorsements for condos, EPA, Leasehold, etc. ($25-$100)
SUBTOTAL ......................................................................................................................... _______
C-2
E. TAXES
1. RECORDING FEES ...................................................................................................... _______
$20-$70
NOTE: Will vary based upon property type (condos higher) Reduce by 30-40% if a refinance
2. RECORDATION/INTANGIBLE/TRANSFER TAXES .................................................... _______
NOTE: Will vary from zero in many states (ex California, Ohio) to over 2% of the sales price
(Maryland). Most states reduce or do not charge taxes on a refinance
SUBTOTAL ......................................................................................................................... _______
F. MISC. FEES TO COMPLETE APPRAISAL OF HOME

1. FINAL INSPECTION .................................................................................................... _______
$50-$100
NOTE: For new homes or other appraisal requirements such as repairs
2. PEST INSPECTION ..................................................................................................... _______

$40-$60
NOTE: May not be required for high rise condos over the fourth floor
3. WELL/SEPTIC INSPECTION ....................................................................................... _______

$75-$250
NOTE: VA will require hook-up to public water supply if available
4. HOME INSPECTION FEE ............................................................................................ _______

$150-$300
NOTE: May be financed on FHA loans up to $200
SUBTOTAL ......................................................................................................................... _______
5. TOTAL CASH REQUIRED
A. Items Paid for At Loan Application ..................................................................... _______

B. Prepaid Items ........................................................................................................ _______
C. Lender Charges .................................................................................................... _______
D. Attorney Fees ........................................................................................................ _______
E. Taxes ..................................................................................................................... _______
F. Misc. Fees to Complete Appraisal of Home ....................................................... _______
Downpayment ............................................................................................................. _______
TOTAL CASH ________
C-3
Appendix D National Real Estate Transaction Taxes and Title Insurance Costs
National Real Estate Tr ansaction Tax es and Title Insur

axes ance Costs
Insurance
Note: These charges will vary from local jurisdiction to local jurisdiction within each State and are
subject to change. They will also vary in accordance with the sales price and the type of transaction
(for example, refinances may not be taxed). The designation of which party pays is also customary
and may vary. Recordation fees (usually less than $50 per transaction) are not included. The title
insurance charges shown are approximate for a $100,000 sales price. The cost per thousand will
typically be higher at a lower sales price and lower at a higher sales price.
Nor theast
Northeast
Connecticut* New Hampshire* Pennsylvania
.61% of sales price by seller 1.05% of sales price split 2.0% of sales price split
$400 for owner’s title $275 for owner’s title +some higher local taxes
$783 for owner’s title
Delaware New Jersey
2-3% of sales price split .35% up to $150,000 Rhode Island*
$325 for owner’s title .50% over $150,000 .28% of sales price by seller
of sales price by seller $390 for owner’s title
Maine* $553 for owner’s title
.44% of sales price split Vermont*
$250 for owner’s title New York* .5%-1.0% of sales price by
.4% of sales price by seller purchaser
Massachusetts* +1.0% NY City $225 for owner’s title
.228% of sales price by seller (.25% on mortgage)
$275 for owner’s title $650 for owner’s title
Southeast
Alabama Kentucky Tennessee
.1% of sales price .1% of sales price split @.115% of mortgage
.15% of mortgage amount $325 for owner’s title @.37% of sales price
split varies by locality
$572 for owner’s title Louisiana $325-$396 for owner’s title
Local taxes only
Arkansas $429 for owner’s title Texas
.22% of sales price by seller None
$325 for owner’s title Maryland* $1,023 for owner’s title
1.5-2.1% of sales price split
District of Columbia .44-.70% of sales price split Virginia
2.2% of sales price split $350 for owner’s title .2% of sales price
$350 for owner’s title .2% of mortgage
Mississippi by buyer
Florida None .1% of sales price by seller
.6-1.5% of sales price by seller Owner’s title varies by locality $390 for owner’s title
.55% of mortgage amount by
buyer $685 for owner’s title North Carolina West Virginia
.2% of equity by seller .44% of sales price by seller
Georgia $200 for owner’s title $390 for owner’s title
.1% of sales price by seller
.3% of mortgage amount by South Carolina
buyer .33% of sales price by seller
Owner’s title varies by locality $275 for owner’s title
D-1
Appendix D National Real Estate Transaction Taxes and Title Insurance Costs
Mid
Midwwest
Idaho Michigan North Dakota
.2-.3% of sales price split .11% of sales price by seller None
$590 for owner’s title $520 for owner’s title $325 for owner’s title
Illinois Minnesota* Ohio

.15-.65% of sales price: varies .23% of mortgage by buyer .1-.4% of sales price by seller
$432 for owner’s title .33% of sales price by buyer $500 for owner’s title
Indiana South Dakota
None Missouri .1% of sales price by seller
$500 for owner’s title None $450 for owner’s title
Iowa* Wisconsin*
.16% of sales price by seller Nebraska .3% of sales price by seller
Title insurance cost varies .15% of sales price by seller $575 for owner’s title
Kansas
.25% of mortgage by buyer
West
Alaska Montana Utah*
None None None
Arizona Nevada Washington

None .13% of equity by seller 1.75% of sales price by seller
California* New Mexico Note: *indicates that State may

.11-.61% of sales price by None require payment of interest on
seller $773 for owner’s title escrows for some mortgages.
$622 for owner’s title Sources include First American
Oklahoma Title Company and Mortgage
Colorado .15% of sales price by seller Bankers Association.
.01% of sales price by seller $380 for owner’s title
Oregon*
Hawaii None
4.01% of sales price split $455 for owner’s title
D-2

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Library of Congress National Serials Data Information

Printed in the United States of America

Chapter 2: Sources of Mortgages ........................................................................................... 9

Chapter 3: Types of Mortgages .............................................................................................. 47

Chapter 5: Comparing Mortgages .......................................................................................... 85

Chapter 6: Refinancing a Mortgage ........................................................................................ 93

Chapter 8: Mortgages, Home Ownership and Taxes .......................................................... 121

Appendix A: Interest Rate Factors

Worksheet 4-1 Purchaser Qualification Sheet ................................................................................. 81

Figure 3-1 The Bi-Weekly Advantage ........................................................................................... 52

Real estate as an investment—the concept of leverage

nomic experts. We feel that the best ap- $75,500

tion to be conservative. We also feel that 60,000

Table 1-2 shows the amount of principal reduc- 30 Year Term

a comparison table which takes our money in the Table 1-2

A few things to note on the Rental equivalency

The mortgage payment as an inflation

Inflation, Tax, and Principal Reduction

Who is eligible to obtain FHA mortgages?

Types of transactions financed under FHA

Types of properties eligible for FHA

Mortgage types offered under FHA

Costs to obtain an FHA mortgage

FHA Maximum Loan-To-Value

NATION AL FHA MAXIMUM LO

Table 2-2 (Continued)

FHA qualification requirements

The Department of Veterans Affairs (VA)

Who is eligible to obtain VA mortgages?

Types of transactions financed under VA

Types of properties eligible for VA

Mortgage types offered under VA

Maximum VA mortgage amount

30 YEAR MORTGAGE RATE CHANGES—A FIFTY YEAR HISTORY

State and local bond issues

Who is eligible for bond issues?

Types of transactions financed

Types of properties eligible

Mortgage types offered

Maximum mortgage amounts

Costs to obtain a bond issue mortgage

Bond issue qualification guidelines

Rural Housing Service (administered by the Farmers Home Administration)

Conventional Conforming Mortgages

Who is eligible for conforming mortgages?

Types of transactions financed

HUD Estimated Median Family Income Limits

Arizona Hawaii Utah

Table 2-7 (Continued)

- Lender can warrant18 compliance

Mortgage types offered

Maximum conforming mortgage amount

The main disadvantage of lender paid insurance is the fact that

Financed Mortgage Insurance

Lender Paid Mortgage Insurance

5% to 350,000 15% to 550,000

Mortgage Level Credit Score LTV Maximum Mortgage Delinquency

Major Mortgage Source Comparisons

Less Federal Tax (-) (-)