🏠Intro to Real Estate Finance Unit 6 – Residential Real Estate Finance

Key Concepts and Terminology

• Mortgage refers to a loan used to purchase real estate, where the property serves as collateral for the loan
• Amortization is the process of gradually paying off a loan over time through regular payments that include both principal and interest
• Loan-to-value (LTV) ratio compares the amount of the mortgage to the appraised value of the property, expressed as a percentage
• Debt-to-income (DTI) ratio measures the borrower's monthly debt payments relative to their gross monthly income, used to assess ability to repay the loan
• Escrow accounts are set up by lenders to hold funds for property taxes and insurance premiums, which are paid on behalf of the borrower
• Private mortgage insurance (PMI) is required for conventional loans with an LTV ratio above 80%, protecting the lender in case of default
• Closing costs include various fees and expenses associated with finalizing a mortgage transaction (origination fees, appraisal fees, title insurance)

Real Estate Market Overview

• Residential real estate market encompasses single-family homes, condominiums, townhouses, and multi-family properties with up to four units
• Housing market is influenced by economic factors such as interest rates, employment levels, and consumer confidence
• Supply and demand dynamics play a crucial role in determining property values and market conditions
  • Low inventory and high demand can lead to a seller's market with rising prices
  • Oversupply and weak demand can result in a buyer's market with stagnant or declining prices
• Demographic trends (population growth, household formation) and migration patterns impact housing demand in specific regions
• Government policies and regulations (zoning laws, tax incentives) can affect the availability and affordability of housing
• Real estate cycles consist of four phases: recovery, expansion, hyper supply, and recession, each characterized by distinct market conditions

Mortgage Basics and Types

• Fixed-rate mortgages maintain the same interest rate throughout the loan term, providing predictable monthly payments
• Adjustable-rate mortgages (ARMs) have interest rates that can change periodically based on a specified index, resulting in fluctuating monthly payments
  • ARMs typically offer lower initial rates compared to fixed-rate mortgages but carry the risk of rate increases over time
• Conventional loans are not insured or guaranteed by the government and often require a down payment of at least 20% to avoid PMI
• FHA loans are insured by the Federal Housing Administration and have more lenient qualification requirements (lower down payments, credit scores)
• VA loans are guaranteed by the Department of Veterans Affairs and offer favorable terms to eligible military service members and veterans
• Jumbo loans exceed the conforming loan limits set by Fannie Mae and Freddie Mac and typically have stricter qualification criteria
• Reverse mortgages allow homeowners aged 62 or older to convert a portion of their home equity into cash, with no monthly mortgage payments required

Loan Qualification Process

• Pre-approval involves submitting financial information to a lender to determine the maximum loan amount and interest rate a borrower qualifies for
• Credit score is a key factor in loan qualification, with higher scores generally resulting in more favorable loan terms and lower interest rates
  • FICO scores range from 300 to 850, with scores above 740 considered very good to exceptional
• Income stability and employment history are assessed to ensure the borrower has a reliable source of income to make mortgage payments
• Debt-to-income (DTI) ratio is calculated by dividing total monthly debt payments by gross monthly income, with a maximum allowable ratio typically around 43%
• Down payment requirements vary by loan type and lender, with conventional loans often requiring 20% to avoid PMI
• Asset documentation (bank statements, investment accounts) is used to verify the borrower's ability to cover down payment and closing costs
• Lenders review the borrower's credit report to identify any red flags (late payments, collections, bankruptcies) that may affect loan approval

Property Valuation Methods

• Appraisal is a professional opinion of a property's market value, conducted by a licensed appraiser
  • Appraisers use the sales comparison approach, comparing the subject property to recently sold similar properties (comparables) to determine value
  • Cost approach estimates the cost to rebuild the property from scratch, adding the value of the land and subtracting depreciation
  • Income approach is used for investment properties, based on the net operating income the property generates divided by a capitalization rate
• Comparative Market Analysis (CMA) is a less formal valuation method used by real estate agents, comparing the property to similar listings and sales in the area
• Automated Valuation Models (AVMs) use statistical modeling and public record data to provide a quick estimate of a property's value
• Home Equity is the difference between the property's market value and the outstanding mortgage balance, representing the owner's financial interest in the property

Risk Assessment and Underwriting

• Underwriting is the process of evaluating a borrower's creditworthiness and the property's value to determine the risk of lending
• Credit risk assesses the borrower's ability and willingness to repay the loan based on credit score, credit history, and debt-to-income ratio
  • Higher credit scores and lower DTI ratios generally indicate lower credit risk
• Collateral risk evaluates the property's value, condition, and marketability as security for the loan
  • Properties in poor condition or located in declining markets may pose higher collateral risk
• Loan-to-value (LTV) ratio is a key measure of risk, with higher LTV ratios indicating greater risk for the lender
• Mortgage insurance (PMI for conventional loans, MIP for FHA loans) is required for high LTV loans to mitigate the lender's risk
• Debt service coverage ratio (DSCR) is used for investment properties, measuring the property's net operating income relative to the mortgage payment
• Lenders may require additional documentation (rent rolls, leases) or reserves for investment properties to ensure the borrower can handle vacancies or repairs

Closing Process and Costs

• Loan estimate is a standardized form provided by the lender, outlining the estimated interest rate, monthly payment, and closing costs
• Closing Disclosure is a final statement of the loan terms and closing costs, provided to the borrower at least three days before closing
• Title search is conducted to ensure the property has a clear title, free of liens or encumbrances that could affect ownership
• Title insurance protects the lender (lender's policy) and the buyer (owner's policy) against title defects or claims against the property
• Appraisal fee covers the cost of the professional property valuation, typically paid by the borrower
• Origination fee is charged by the lender for processing the loan, often expressed as a percentage of the loan amount
• Discount points are optional upfront fees paid to reduce the loan's interest rate, with each point equal to 1% of the loan amount
• Escrow funds for property taxes and insurance are typically collected at closing and held in a separate account by the lender
• Prorations for property taxes, HOA fees, and other expenses are adjusted at closing based on the date of ownership transfer

Legal and Regulatory Considerations

• Real Estate Settlement Procedures Act (RESPA) requires lenders to provide borrowers with disclosures about settlement costs and prohibits kickbacks or referral fees
• Truth in Lending Act (TILA) mandates that lenders disclose the annual percentage rate (APR), finance charges, and other key terms of the loan
• Fair Housing Act prohibits discrimination in housing transactions based on race, color, religion, sex, national origin, familial status, or disability
• Equal Credit Opportunity Act (ECOA) forbids discrimination in lending based on race, color, religion, national origin, sex, marital status, age, or receipt of public assistance
• Dodd-Frank Wall Street Reform and Consumer Protection Act established the Consumer Financial Protection Bureau (CFPB) to regulate financial products and services
• Qualified Mortgage (QM) rules set standards for lender underwriting, including limits on fees, points, and risky loan features
• Predatory lending practices (excessive fees, loan flipping, equity stripping) are illegal and can result in severe penalties for lenders
• Foreclosure laws vary by state and govern the process of repossessing a property when a borrower defaults on the mortgage