14 Hour Mortgage Broker 2007

18,262

Published on

I wrote all 14 hours for this CE course.

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total Views
18,262
On Slideshare
0
From Embeds
0
Number of Embeds
1
Actions
Shares
0
Downloads
1
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

14 Hour Mortgage Broker 2007

  1. 1. Mortgage Brokering/Lending 14-Hour Continuing Education Course 2 0 0 7 E d i t i o n 14-Hour Continuing Education Course 14-Hour Continuing Education Course ATTENTION! Our mortgage brokering/lending course is expiring 9-30-2007!
  2. 2. vi     Bert Rodgers Schools of Real Estate, Inc. Acknowledgements Bert Rodgers Schools of Real Estate, Inc. expresses our gratitude and appreciation to the thousands of Mortgage Professionals who have completed our 14-hour course to fulfill their continuing education requirements. We would like to thank the author of this edition, Janine Spiegelman. We recognize her expertise and appreciate her participation. We also want the Student Services Department—both the customer contact employees and those “behind the scenes” processing all the paperwork—to know how much we appreciate their hard work, day after day, making sure our valued students are satisfied customers. And we certainly are grateful to our Publications Department staff. No matter what obsta- cles you encounter in putting together these editions, you always create a product that, year after year, our customers say is by far the best in the industry. Finally, Bert Rodgers Schools would like to thank Julie Wild of Wild Dezign for her typeset- ting expertise and patience, and Mark Mazzuki of Digital Ink Design Group for his cover design of this edition and his design of all our marketing materials. Lori J. Rodgers, President
  3. 3. Table of Contents Founder Bert Rodgers President Lori J. Rodgers Administrative Vice President William E. Giffard Director of Operations Tom Harner Director of Information Systems Alison M. Harner Director of Finance Aaron Pulone Project managers Valerie Churchillo Lisa Lacey Instructor Janine Spiegelman Project Coordinators Michelle Headley Jerry Schmitt Product Support Manager Kelli Finnigan Student Services supervisor Patti Pasquini Student Services representatives Barbara Dolnick Anthony Fasciano Colletta Finnigan Mark Forsman Jenncie Grove Laraine Jansen Mary Killoran Shirley Samson Kayla Smillie Christopher Smith Roman Vizvary Typesetting Wild Dezign Printing Action Printing 14-Hour MORTGAGE BROKERING/LENDING Continuing Education Course w MODULE 1 Florida Mortgage Brokerage and Lending Act Rules and Regulations | 1 w MODULE 2 Credit Scores and Credit Scoring | 17 w MODULE 3 Exotic and Nontraditional Mortgages | 23 w MODULE 4 Subprime Loans and Prepayment Penalties | 31 w MODULE 5 Lack of Credit Documentation Promotes Mortgage Fraud | 39 w MODULE 6 Updates on Flood and Hazard Insurance | 45 w MODULE 7 Affordable Housing | 55 w MODULE 8 New and Updated Fannie Mae/Freddie Mac Appraisal and Property Report Forms | 61 Registration/Affidavit Form
  4. 4. viii     Bert Rodgers Schools of Real Estate, Inc. Janine Spiegelman has been a licensed Florida Mortgage Broker since 1987 and has taught the mortgage pre-licensure course since 1999. She has worked for the State of Florida, Department of Banking and Finance as a Financial Examiner/Analyst II. In the mortgage field, she has held every position possible–processor, closer, underwriter, post closer, mort- gage broker, and wholesale account executive. She has her own real estate brokerage and enjoys working with first-time home buyers. Janine is our continuing education instructor for real estate and mortgage brokering/lending. Bert Rodgers Schools of Real Estate, Inc. ©2007 All rights reserved, including the right to reproduce this manual or any portion of this manual in any form, or to use it for teaching purposes without the express written consent of the copyright holder. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Bert Rodgers Schools of Real Estate, Inc. shall not be liable in any way for failure to receive and/or process your Registration/Affidavit Form within any specific time period. It is your responsibility to ensure that you have complied with your license renewal requirements in a timely manner. Bert Rodgers Schools of Real Estate, Inc. recognizes and respects its students’ privacy. Course records are confidential, and the School does not sell or rent students’ names or other information to any company or organization. Cover design: Digital Ink Design Group ISBN: 1-891753-40-1 Printed in the United States of America Author Biography
  5. 5. © 2007 Bert Rodgers Schools of Real Estate, Inc. Learning Objectives After completing this module, you should be able to: Florida Mortgage Brokerage and Lending Act Rules and Regulations M O D U L E 1 1. Summarize the changes made to Chapter 494 F.S. effective October 1, 2006. 2. List the changes to Chapter 69V-40 Florida Administrative Code made through 2004. 3. Summarize the organizational structure of the Florida Department of Financial Services, including the Financial Services Commission and the Office of Financial Regulation. 4. Explain the powers and duties of the Financial Services Commission and the Office of Financial Regulation. 5. Explain the penalties, which could be imposed for a violation of Chapter 494, F.S. 6. Identify the prohibited practices pursuant to Chapter 494. 7. Explain the purpose for the enactment of the Florida Fair Lending Act. 8. Identify the types of transactions covered by the Florida Fair Lending Act. 9. Define a high-cost home loan. 10. Identify the acts prohibited by the Florida Fair Lending Act. 11. Identify the disclosure requirements of the Florida Fair Lending Act. 12. Explain the enforcement and penalties of any violation of the Florida Fair Lending Act. The Department of Financial Services regulates mortgage broker individuals (MB), mortgage broker- age businesses (MBB), mortgage lenders (ML), and correspondent mortgage lenders (CL) by the use of Florida Statutes (F.S.) and the Florida Administrative Code (F.A.C.). Chapter 494, F.S., is known as the Florida Mortgage Brokerage and Mortgage Lending Act Rules and Regulations. Chapter 494 originally became effective in October 1991, and several sig- nificant amendments have been made since 1991. Chapter 69V-40 of the Florida Administrative Code (formerly Chapter 3D-40 F.A.C.) is called Rules Regulation Mortgage Brokers. Certain minor changes to Chapter 69V-40 were made effective on August 2, 2002, and a few minor amendments were made between 2003 and 2004. The purpose of this module is to review Florida mortgage brokerage rules and regulations including changes effective October 1, 2006. In 2002, legislation placed the regulation of bank- ing, securities, and insurance under two appointed officials who are selected by the Financial Services Commission. The Financial Services Commission serves as agency head for the Office of Financial Regulation (OFR or Office) and the Office of Insurance Regulation (OIR). The commission is composed of the governor and Cabinet. The com- mission appoints the commissioner of the OFR and the commissioner of the OIR. Although both offices are administratively housed within the Department of Financial Services, they report directly to the Financial Services Commission, headed by the newly elected Chief Financial Officer, Alex Sink. The Office of Financial Regulation has offices located in Miami, Fort Lauderdale, West Palm Beach, Tampa, Orlando, Jacksonville, Pensacola, and Fort Myers. The regional offices are primarily responsible for conducting exam- inations to ensure regulatory compliance by financial institutions and financial service companies. The Office is dedicated to safeguarding the private financial interests of the public by licensing, char- tering, examining, and regulating financial institu- tions and financial service companies in the State of Florida. The Office strives to protect consumers from financial fraud while preserving the integrity of Florida’s markets and financial service industries. INTRODUCTION
  6. 6.      Module 1 This is the Office’s mission statement found at www.flofr.com/Director/abouttheoffice.htm Within the Office are 2 Divisions. The first is the Division of Financial Institutions. This division licenses, examines, and regulates all state-authorized or state-chartered financial institutions to ensure they operate in a safe and sound manner and in compliance with applicable statutes and rules. Those institutions include commercial banks, credit card banks, credit unions, non-deposit trust companies, savings banks, savings and loans, and international bank offices. The second division within the Office is the Division of Securities and Finance. Within this division are three Bureaus— the Bureau of Financial Regulation; the Bureau of Securities Regulation; and the Bureau of Regulatory Review. The Bureau of Finance Regulation regulates retail installment sales busi- nesses, consumer finance companies, mortgage bro- kers and lenders, collection agencies, and money transmitters. The bureau provides consumer protec- tion from illegal or improper activities performed by these companies. The Bureau of Securities Regulation protects the public from investment and securities fraud. The Bureau of Regulatory Review reviews all applications for a financial services firm or a securi- ties firm, reviews individual applications, and either approves, places licensing restrictions, or denies licen- sure based upon its findings (See Figure 1.1). RECENT CHANGES IN FLORIDA STATUTES REGULATING MORTGAGE BROKERAGE AND MORTGAGE LENDING This section discusses the more significant changes in the Florida Statute Chapter 494 regulating mortgage brokerage and mortgage lending effective October 1, 2006. N E W Definition Control person means an individual, partnership, corporation, trust, or other organization that possesses the power, directly or indirectly, to direct the man- agement or policies of a company, whether through ownership of securities, by contract, or otherwise. A person is presumed to control a company if, with respect to a particular company, that person: (a) Is a director, general partner, or officer exercising executive responsibility or having similar status or functions; (b) Directly or indirectly may vote 10 percent or more of a class of voting securities or sell or direct the sale of 10 percent or more of a class of voting secu- rities; or (c) In the case of a partnership, may receive upon dis- solution or has contributed 10 percent or more of the capital (Chapter 494.001(9)(a-c), F.S.). Commissioner Financial Regulation Deputy Commissioner Financial Regulation Chief, Financial Investigations General Counsel Inspector General Director Division of Financial Institutions Director Division of Securities Office of Financial Regulation Chief, Bank Regulation District I Chief, Credit Union Regulation Chief, Securities Regulation Chief, Finance Regulation Chief, Regulatory Review Chief, Money Transmitter Director, Cabinet Legislative Affairs Director Division of Finance Chief, Bank Regulation District II Chief, Regulatory Review Director of Auditing Figure 1.1 Source: www.flofr.com/Director/OFRorgchart.pdf Office of Financial Regulation Flow Chart
  7. 7. Florida Mortgage Brokerage and Lending Act Rules and Regulations     N E W Powers and Duties of the Commission and Office Allows the Office to require the electronic filing of applications, renewals, and fees, unless granted a waiver by OFR due to a hardship. Prior to this change, the only license type that could file an application online was a mortgage broker (Chapter 494.0011(2)(6), F.S.). N E W Books, Accounts, and Records; Maintenance; Examinations by the Office Authorizes the commission to adopt rules for the requirements for the destruction of records main- tained by licensees after the retention period has expired ( Chapter 494.0016(4), F.S.). N E W Mortgage Business Schools Requires permitted mortgage business schools to electronically report to the Office the names of pupils who have successfully completed required training courses (Chapter 494.0029(4), F.S.). N E W Licensure as a Mortgage Brokerage Business; Mortgage Broker’s License Provides that applications are not deemed received until all required fees are received (Chapters 494.0031(2)(a); 494.0033(2)(c), F.S.). N E W Renewal of Mortgage Brokerage Business License or Branch Office License The license for a branch office must be renewed in conjunction with the renewal of the mortgage broker- age business license (Chapter 494.0032(1)). N E W Mortgage Broker’s License Allows the Office to contract with a third party ven- dor to administer the mortgage broker test. This will allow the test to be conducted electronically at mul- tiple locations several times a week versus the old once a month process at limited locations (Chapter 494.0033(2)(b), F.S.). N E W Mortgage Brokerage Business Branch Offices; Principal Place of Business Requirements Deleted Chapter 494.0036(3), F.S. and Chapter 494.0039(3), F.S. Eliminated from the statute the requirement to display main office, branch office, and individual licenses. N E W Requirements of Licensees Provides that each licensee shall report any change in the principal broker, principal representative, offi- cers, partners, members, joint venturers, directors, control persons or any individual who is the ultimate equitable owner of 10% or greater interest (Chapter 494.004(6). F.S.). Provides that a change of control whether through the power to direct management, ownership or oth- erwise shall require an application to be submitted to the OFR unless a waiver has been granted (Chapter 494.004(6)(a-d), F.S.). N E W Administrative Penalties and Fines; License Violations Authorizes disciplinary action if fees are paid with a bad check. (Chapters 494.0041(2)(s) and 494.0072(2)(s), F.S.). Provides grounds for disciplinary action when a final judgment is entered against an applicant or licensee in a civil action upon grounds of fraud, embezzlement, misrepresentation, or deceit (Chapters 494.0041(2)(t) and 494.0072(2)(t), F.S.). Provides grounds for disciplinary action when action is taken by other federal and state regulatory organiza- tions located in or outside the State of Florida involving securities, insurance, real estate, mortgage brokers and lenders, or other related or similar industries (Chapters 494.0041(2)(u)1.2. and 494.0072(2)(u)1.2.,F.S.). N E W Mortgage Lender’s License Requirements; Correspondent Mortgage Lender’s License Requirements; Savings Clause; Branch Offices Provides that applications are not deemed received until all required fees are received (Chapters 494.0061(2)(b), 494.0062(2)(b), 494.0065(3)(5)(b) and 494.0066(2), F.S.). Audited financial statements of all licensed lend- ers have to be in accordance with United States
  8. 8.      Module 1 generally accepted accounting principles (Chapters 494.0061(2)(c), 494.0062(2)(c) and 494.0065(2)(5)(c), F.S.). Provides under certain conditions that existing principal representatives can be grandfathered in without class or testing requirements (Chapters 494.0061(2)(f)(8-9) and 494.0062(2)(f)(11-12) and 494.0065(4)(c)1.2.(10), F.S.). N E W Renewal of Mortgage Lender’s License; Branch Office License Renewal Chapter 494.0064(1)(b), F.S. deleted. Eliminated the requirement to report the continuing education of loan associates when renewing a lender’s license. N E W Requirements of Licensees Under Chapters 494.006-.0077 Chapter 494.0067(1), F.S. deleted. Eliminated from the statute the requirement to display main and branch office licenses. Provides that each licensee shall report any change in the officers, partners, members, joint venturers, direc- tors, or control persons. (Chapter 494.0067(4), F.S). Provides that a change of control whether through the power to direct management, ownership or oth- erwise shall require an application to be submitted to the OFR unless a waiver has been granted. (Chapter 494.0067(4)(a-d),F.S). Changes between 2002 and 2004 to the Rules of the Florida Administrative Code The most significant changes were that the Rules Regulation Mortgage Brokers were moved from 3D- 40 F.A.C. to a new chapter 69V-40 F.A.C. and all ref- erences to the Department of Banking and Finance were replaced with the Financial Services Commission and the Office of Financial Regulation, depending upon the specific division of responsibility between the departments. See Table 1.1 To access any of the required forms, go to website and select the appropriate form. www.flofr.com/licensing/MBlist.htm To access Chapter 494 online, go to www. leg.state.fl.us/Statutes/index.cfm?App_ mode=Display_StatuteURL=Ch0494/ titl0494.htmStatuteYear=2006Title=- 2006-Chapter%20494 To access the Florida Administrative Code, Rules69V-40,gotowww.flofr.com/licensing/ RulesStatutes/Rule69V-40.htm Table 1.1 Updates to the Rules of the Florida Administrative Code between 2002 and 2004 Books and Records 69V-40.170 Amended to substitute the Office of Financial Regulation for all references to the Department of Banking and Finance. Application Procedure for Mortgage Broker License 69V-49.031(1) Provides that all applications for licensure as a mortgage bro- ker must be filed with the OFR. The address is: Office of Financial Regulation 200 East Gaines Street Tallahassee, Florida 32399-0375 69V-40.031(1)(a) The application form for Licensure as a Mortgage Broker changed to OFR-MB-101, and is available by mail from the OFR. 69V-40.031(1)(c) The fee which must accompany the applicant’s fingerprint card changed from $15.00 to $23.00. In the remainder of this section, all references to the Department of Banking and Finance changed to the Office of Financial Regulation. Application Procedure for Mortgage Brokerage Business License 69V-40.051 All applications for licensure as a mortgage brokerage busi- ness must now be filed with the OFR. The form that must be used for this application is OFR-MB-201, and can be obtained by mail from the OFR or accessed online at http://www.flofr. com/licensing/Forms/MBBapp.pdf
  9. 9. Florida Mortgage Brokerage and Lending Act Rules and Regulations     Table 1.1 Updates to the Rules of the Florida Administrative Code between 2002 and 2004 69V-40.051(2) Regarding the fingerprint cards and Biographical Summary, now provides as follows: Each ultimate equitable owner of 10% or greater inter- est, the chief executive officer and each director of an entity applying for licensure as a mortgage brokerage business, shall submit a completed fingerprint card and Biographical Summary, Form OFR-MBB-BIO-1 (revised 10/99), to the Office of Financial Regulation along with a $23 nonrefundable processing fee. Form OFR-MBB-BIO-1 is hereby incorporated by reference and available by mail from the Office of Financial Regulation, 200 East Gaines Street, Tallahassee, Florida 32399-0375. All former references to the Department of Banking and Finance have been changed in this section to the Office of Financial Regulation. Application Procedure for Change in Ownership or Control of Saving Clause Mortgage Lending 69V-40.100 All references to the Department of Banking and Finance have been changed to the Office of Financial Regulation. The ap- plication for Change in Ownership or Control of Saving Clause Mortgage Lending must use the form OFR-MLST. The form must be mailed to the Office at the address. The same changes to the fingerprint card filing and Biographical Summary that were made to the other license application regula- tions, (i.e. form OFR-ML-BIO-1 and the fee of $23), were also made to this section. Application Procedure for Mortgage Lender License 69V-40.200 The application form for licensure as a mortgage lender changed to OFR-ML-222 and is to be mailed to the Office at the address. Further, the surety bond must be submitted on form OFR-ML-444, Mortgage Brokerage and Mortgage Lending Act Surety Bond. The completed fingerprint card and Biographical Summary form OFR- ML-BIO-1, and the nonrefundable, processing fee of $23 must be submitted to the Office. All references to the Department of Banking and Finance have been changed to the Office of Finan- cial Regulation. Mortgage Lender License, Mortgage Lender License Pursuant to Saving Clause, and Branch Office License Renewal and Reactivation 69V-40.205 The form for renewal and reactivation of a mortgage lender license is OFR-ML-R, and the form for renewal and reactivation of a mortgage lender license pursuant to saving clause is OFR-ML- RS. The form for branch office renewal is OFR-ML-RB, Mort- gage Lender and Correspondent Mortgage Lender Branch Office License Renewal and Reactivation Form. All forms must be filed with the Office. Application Procedure for Correspon- dent Mortgage Lender License 69V-40.220 Changed the applicable forms, processing fees, and references to the Office of Financial Regulation. The application form for licensure as a correspondent mortgage lender is OFR-CL-333. The surety bond form is OFR-ML-444. The fingerprint card and Biographical Summary form is OFR-CL-BIO-1, and the processing fee is now $23. All forms must be filed with the Office. Correspondent Mortgage Lender License and Branch Office License Renewal and Reactivation 69V-40.225 Changed the applicable forms and references to the Office of Financial Regulation. The renewal and reactivation form for correspondent mortgage lender license is form OFR-CL-R. The surety bond form is OFR-ML-444. The Mortgage Lender and Cor- respondent Mortgage Lender Branch Office License Renewal and Reactivation form is OFR-ML-RB. All forms must be filed with the Office. Application Procedure for Mortgage Lender or Correspondent Mortgage Lender Branch Office License 69V-40.240 Changed the application form and references to the Office of Financial Regulation. The application form for mortgage lender branch office or correspondent mortgage lender branch office license is OFR-ML-222B. All forms must be filed with the Office. Principal Representative 69V-40.242 Changed the applicable form and references to the Office of Financial Regulation. The Principal Representative Designation form is OFR-ML/CL-PR. All forms must be filed with the Office. Source: Compiled by author.
  10. 10.      Module 1 PART I: GENERAL PROVISIONS (494.001-494.00295) The Financial Services Commission As introduced at the beginning of this module, the Financial Services Commission serves as agency head for the Office of Financial Regulation (OFR or Office) andtheOfficeofInsuranceRegulation(OIR).OFRand OIR are administratively housed within the Depart­- ment of Financial Services, headed by the Chief Financial Officer. The Office is responsible for con- ducting financial investigations into allegations of sus- pected illegal financial activities within its jurisdiction. Powers and Duties of the Commission and Office The Office of Financial Regulation is responsible for the administration and enforcement of Chapter 494.001-494.0077, F.S. The Financial Services Com­­mission may adopt rules pursuant to Chapters 120.563(1), F.S and 120.54, F.S to implement Chapters 494.001-494.0077, F.S. The Commission may adopt rules requiring electronic submission of any forms, documents, or fees required by this act if such rules reasonably accommodate technological or financial hardship. The Commission may prescribe by rule requirements and procedures for obtaining an exemption due to a technological hardship. The Commission may also adopt rules to accept certifica- tion of compliance with requirements of Chapter 494, F.S. in lieu of requiring submission of documents. The grant or denial of any license under this chapter must be in accordance with Chapter 120.60, F.S. The Office: has the power to issue and to serve subpoenas and subpoenas duces tecum to compel the attendance of witnesses and the production of all books, accounts, records, and other documents and materials rel- evant to an examination or investigation. or its duly authorized representative, has the power to administer oaths and affirmations to any person. may conduct an investigation of any person when- ever the Office has reason to believe, either upon complaint or otherwise, that any violation of 494.001-494.0077 F.S. has been committed or is about to be committed. • • • may, at intermittent periods, conduct examinations of any licensee or other person under the provi- sions of 494.001-494.0077 F.S. may bring action through its own counsel in the name and on behalf of the state against any person who has violated or is about to violate any provi- sion of 494.001-494.0077 F.S. or any rule of the commission or order of the Office issued under 494.001-494.0077 F.S. to enjoin the person from continuing in or engaging in any act in furtherance of the violation. has the power to issue and serve upon any person an order to cease and desist and to take corrective action whenever it has reason to believe the per- son is violating, has violated, or is about to violate any provision of 494.001-494.0077 F.S., any rule or order issued under 494.001-494.0077 F.S., or any written agreement between the person and the Office. All procedural matters relating to issuance and enforcement of such a cease and desist order are governed by the Administrative Procedure Act. has the power to order the refund of any fee directly or indirectly assessed and charged on a mortgage loan transaction which is unauthorized or exceeds the maximum fee specifically authorized in 494.001-494.0077 F.S. may prohibit the association by a mortgage broker business, or the employment by a mortgage lender or correspondent mortgage lender, of any person who has engaged in a pattern of misconduct while an associate of a mortgage brokerage business or an employee of a mortgage lender or correspondent mortgage lender. For the purpose of this subsec- tion, the term “pattern of misconduct” means the commission of three or more violations of ss. 494.001-494.0077 or the provisions of Chapter 494 in effect prior to October 1, 1991, during any one year period or any criminal conviction for violating ss. 494.001-494.0077 or the provisions of Chapter 494 in effect prior to October 1, 1991. Penalties Chapter 494.0018 provides whoever knowingly vio- • • • • • MORTGAGE BROKERAGE LICENSE LAW Chapter 494, F.S., is divided into five parts: Part I, General Provisions (494.001-494.00295); Part II, Mortgage Brokers (494.003-494.0043); Part III, Mortgage Lenders (494.006-494.0077); Part IV, Florida Fair Lending Act (494.0078-494.00797); and Part V, Loans Under the Florida Uniform Land Sales Practices Law (494.008).
  11. 11. Florida Mortgage Brokerage and Lending Act Rules and Regulations     lates any provision of Chapters 494.0041(2)(e), (f), or (g); 494.0072 (2)(e), (f), or (g); or 494.0025 (1), (2), (3), (4), or (5), is guilty of a felony of the third degree, except that any person convicted of a violation of any provision of 494.001-494.0077 F.S., in which viola- tion the total value of money and property unlawfully obtained exceeded $50,000 and there were five or more victims, is guilty of a felony of the first degree. All the violations are punishable as provided in Chapters 775.082 F.S., 775.083 F.S., or 775.084 F.S. Each such violation constitutes a separate offense. In addition, if a mortgage transaction is made in violation of any pro- vision of Chapters 494.001-494.0077 F.S., the person making the transaction and every licensee, director, or officer who participated in making the transaction are jointly and severally liable to every party to the transaction in an action for damages incurred by the party or parties. However, a person is not liable under this section upon showing that such person’s licens- ees, officers, and directors who participated in making the transaction, if any, acted in good faith and with- out knowledge and, with the exercise of due diligence, could not have known of the act committed in viola- tion of Chapters 494.001-494.0077, F.S. Prohibited Practices Chapter 494.0025 F.S. provides that it is unlawful for any person: (1) To act as a mortgage lender in this state without a current, active license issued by the Office pur- suant to 494.006-494.0077, F.S. (2) To act as a correspondent mortgage lender in this state without a current, active license issued by the Office pursuant to 494.006-494.0077, F.S. (3) To act as a mortgage broker in this state without a current, active license issued by the Office pur- suant to 494.003-494.0043, F.S. (4) In any practice or transaction or course of busi- ness relating to the sale, purchase, negotiation, promotion, advertisement, or hypothecation of mortgage transactions, directly or indirectly: (a) To knowingly or willingly employ any device, scheme, or artifice to defraud; (b) To engage in any transaction, practice, or course of business which operates as a fraud upon any person in connection with the pur- chase or sale of any mortgage loan; or (c) To obtain property by fraud, willful misrep- resentation of a future act, or false promise. (5) In any matter within the jurisdiction of the Office, to knowingly and willfully falsify, con- ceal, or cover up by a trick, scheme, or device a material fact, make any false or fraudulent state- ment or representation, or make or use any false writing or document, knowing the same to con- tain any false or fraudulent statement or entry. (6) To violate 655.922(2) F.S., subject to 494.001- 494.0077 F.S. (7) Who is required to be licensed under ss. 494.006 - 494.0077, to fail to report to the Office the failure to meet the net worth requirements of 494.0061 F.S., 494.0062 F.S., or 494.0065 F.S. within 48 hours after the person’s knowledge of such failure or within 48 hours after the person should have known of such failure. (8) To pay a fee or commission in any mortgage loan transaction to any person or entity other than a mortgage brokerage business, mortgage lender, or correspondent mortgage lender, operating under an active license, or a person exempt from licensure under this chapter. (9) To record a mortgage brokerage agreement or any other document, not rendered by a court of competent jurisdiction, which purports to enforce the terms of the mortgage brokerage agreement. (10) To use the name or logo of a financial institution, as defined in 655.005(1), F.S., or its affiliates or subsidiaries when marketing or soliciting exist- ing or prospective customers if such marketing materials are used without the written consent of the financial institution and in a manner that would lead a reasonable person to believe that the material or solicitation originated from, was endorsed by, or is related to or the responsibility of the financial institution or its affiliates or sub- sidiaries.
  12. 12.      Module 1 PART II AND III: MORTGAGE BROKERS AND MORTGAGE LENDERS All the relevant changes made to Chapter 494, F.S. were discussed at the beginning of this module. Included here is a brief recap of the changes to Chapter 494.003-494.0077, F.S. PART IV: FLORIDA FAIR LENDING ACT ABUSIVE MORTGAGE LENDING In 494.0078, F.S. the Florida Legislature found that: “abusive mortgage lending has become a problem in this state even though most high-cost home loans do not involve abusive mortgage practices. One of the most common forms of abusive lending is the making of loans that are equity-based rather than income-based. The financing of points and fees in these loans provides immediate income to the originator and encourages creditors to repeatedly refinance home loans. As long as there is sufficient equity in the home, an abusive creditor benefits even if the borrower is unable to make the payments and is forced to refinance. The financing of high points and fees causes the loss of equity in each refinanc- ing and often leads to foreclosure. Abusive lending has threatened the viability of many communities and caused decreases in home ownership. While the marketplace appears to oper- ate effectively for conventional mortgages, too many homeowners find themselves victims of overreach- ing creditors who provide loans with unnecessarily high costs and terms that are unnecessary to secure repayment of the loan. The Legislature finds that as competition and self-regulation have not eliminated the abusive terms from home-secured loans, the consumer protection provisions of this act are nec- essary to encourage fair lending.” DEFINITIONS Chapter 494.0079, F.S. sets forth the following defi- nitions. Affliate: Any company that controls, is controlled by, or is in common control with another company, as set forth in 12 U.S.C. 1841 et seq. and the regulations adopted thereunder. Allows the Office to contract with a third party ven- dor to administer the mortgage broker test. Provides that applications are not deemed received until all required fees are received. Authorizes dis- ciplinary action if fees are paid with a bad check. Provides that each licensee shall report any change in the principal broker, principal representative, officers, partners, members, joint venturers, direc- tors, control persons or any individual who is the ultimate equitable owner of 10% or greater inter- est. Provides that a change of control whether through the power to direct management, ownership or oth- erwise shall require an application to be submitted to OFR unless a waiver has been granted. Audited financial statements of all licensed lend- ers have to be in accordance with U.S. generally accepted accounting principles. Provides under certain conditions that existing • • • • • • principal representatives can be grandfathered in without class or testing requirements. Eliminates the requirement to display main and branch office licenses. Eliminates the requirement to display individual mortgage broker licenses. Eliminates the requirement to report the continu- ing education of loan “Associates” when renewing a lender’s license. Provides grounds for disciplinary action when a final judgment is entered against an applicant or licensee in a civil action upon grounds of fraud, embezzlement, misrepresentation, or deceit. Provides grounds for disciplinary action when action is taken by other federal and state regula- tory organizations located in or outside the State of Florida involving securities, insurance, real estate, and lending activities. • • • • •
  13. 13. Florida Mortgage Brokerage and Lending Act Rules and Regulations     Annual percentage rate (APR): The annual percent- age rate for the loan calculated according to the provi- sions of 15 U.S.C. 1606 and the regulations adopted thereunder by the Federal Reserve Board. Borrower: Any natural person obligated to repay a loan, including, but not limited to, a co-borrower, co- signor, or guarantor. Bridge loan: A loan with a maturity of less than 18 months that only requires the payment of interest until such time as the entire unpaid balance is due and payable. Commission: The Financial Services Commission. Office: The Office of Financial Regulation of the commission. Lender: Any person who makes a high-cost home loan or acts as a mortgage broker or lender, finance company, or retail installment seller with respect to a high-cost home loan, but shall not include any entity chartered by the United States Congress when engag- ing in secondary market mortgage transactions as an assignee or otherwise. Residential mortgage transaction: A transaction in which a mortgage, deed of trust, purchase money security interest arising under an installment sales contract, or equivalent consensual security interest is created or retained against the consumer’s dwelling to finance the acquisition or initial construction of such dwelling. (15 U.S.C.) 1602(w) HIGH-COST HOME LOANS Definition The provisions of the Florida Fair Lending Act deal primarily with high-cost home loans. High-cost home loans are defined by 15 U.S.C. 1602(aa), which provides in pertinent part as follows: (1) A mortgage referred to in this subsection means a consumer credit transaction that is secured by the consumer’s principal dwelling, other than a resi- dential mortgage transaction, a reverse mortgage transaction, or a transaction under an open end credit plan, if— (A) the annual percentage rate at consummation of the transaction will exceed by more than 10 percentage points the yield on Treasury secu- rities having comparable periods of maturity on the fifteenth day of the month immediately preceding the month in which the application for the extension of credit is received by the creditor; or (B) the total points and fees payable by the con- sumer at or before closing will exceed the greater of— (i) 8 percent of the total loan amount; or (ii) $547.00, for the year 2007. (2) (A) After the 2-year period beginning on the effective date of the regulations promulgated under section 155 of the Riegle Community Development and Regulatory Improvement Act of 1994, and no more frequently than bien- nially after the first increase or decrease under this subparagraph, the Board may by regula- tion increase or decrease the number of per- centage points specified in paragraph (1)(A), if the Board determines that the increase or decrease is— (i) consistent with the consumer protections against abusive lending provided by the amendments made by subtitle B of title I of the Riegle Community Development and Regulatory Improve­ment Act of 1994; and (ii) warranted by the need for credit. (B) An increase or decrease under subparagraph (A) may not result in the number of percent- age points referred to in subparagraph (A) being— (i) less that 8 percentage points; or (ii) greater than 12 percentage points. (C) In determining whether to increase or decrease the number of percentage points referred to in subparagraph (A), the Board shall consult with representatives of consumers, including low-income consumers, and lenders. (3) The amount specified in paragraph (1)(B)(ii) shall be adjusted annually on January 1 by the annual percentage change in the Consumer Price Index, as reported on June 1 of the year preceding such adjustment. (4) For purposes of paragraph (1)(B), points and fees shall include— (A) all items included in the finance charge, except interest or the time-price differential; (B) all compensation paid to mortgage brokers; (C) each of the charges listed in section1605(e) of this title (except an escrow for future payment of taxes), unless— (i) the charge is reasonable; (ii) the creditor receives no direct or indirect compensation; and (iii) the charge is paid to a third party unaffili- ated with the creditor; and (D) such other charges as the Board determines to be appropriate.
  14. 14. 10     Module 1 PROHIBITED ACTS Chapter 494.00791,F.S. provides for prohibited acts involving high-cost loans. (1) Prepayment Penalties (a) A high-cost home loan may not contain terms that require a borrower to pay a pre- payment penalty for paying all or part of the loan principal before the date on which the payment is due. (b) Notwithstanding paragraph (a), a lender making a high-cost home loan may include in the loan contract a prepayment fee or penalty, for up to the first 36 months after the date of consummation of the loan, if: 1. The borrower has also been offered a choice of another product without a pre- payment penalty. 2. The borrower has been given, at least 3 business days prior to the loan consum- mation, a written disclosure of the terms of the prepayment fee or penalty by the lender, including the benefit the bor- rower will receive for accepting the pre- payment fee or penalty through either a reduced interest rate on the loan or reduced points or fees. (2) Default Interest Rate A high-cost home loan may not provide for a higher interest rate after default on the loan. However, this prohibition does not apply to interest rate changes in a variable rate loan oth- erwise consistent with the provisions of the loan documents, provided the change in interest rate is not triggered by a default or the acceleration of the interest rate. (3) Balloon Payments A high-cost home loan having a term of less than 10 years may not contain terms under which the aggregate amount of the regular periodic pay- ments would not fully amortize the outstanding principal balance. However, this prohibition does not apply when the payment schedule is adjusted to account for the seasonal or irregular income of the borrower or if the loan is a bridge loan. (4) Negative Amortization A high-cost home loan may not contain terms under which the outstanding principal balance will increase at any time over the course of the loan because the regular periodic payments do not cover the full amount of the interest due. (5) Prepaid Payments A high-cost home loan may not include terms under which more than two periodic payments required under the loan are consolidated and paid in advance from the loan proceeds provided to the borrower. (6) Extending Credit Without Regard To The Payment Ability Of The Borrower A lender making a high-cost home loan shall not engage in any pattern or practice of extending high-cost home loans to borrowers based upon the borrowers’ collateral without regard to the borrowers’ ability to repay the loan, including the borrowers’ current and expected income, current obligations, and employment. (7) Payments To A Home Contractor A lender shall not make any payments to a con- tractor under a home improvement contract from amounts of a high-cost home loan other than: (a) In the form of an instrument that is payable to the borrower or jointly to the borrower and the contractor; or (b) At the election of the borrower by a third- party escrow agent in accordance with terms established in a written agreement signed by the borrower, the lender, and the contractor prior to the date of payment. (8) Due-On-Demand Clause A high-cost home loan may not contain a provi- sion that permits the lender, in its sole discre- tion, to call or accelerate the indebtedness. This provision does not prohibit acceleration of the loan due to the borrower’s failure to abide by the terms of the loan, or due to fraud or material misrepresentation by the consumer in connec- tion with the loan. (9) Refinancing Within an 18-Month Period (a) A lender, its affiliate, or an assignee shall not refinance any high-cost home loan to the same borrower within the first 18 months of the loan when the refinancing does not have a reasonable benefit to the borrower considering all of the circumstances, includ- ing, but not limited to, the terms of both the new and refinanced loans, the cost of the new loan, and the borrower’s circumstances. (b) A lender or assignee shall not engage in acts or practices to evade this requirement, including a pattern or practice of arrang- ing for the refinancing of the lender’s or assignee’s own loans by affiliated or unaffili- ated lenders or modifying a loan agreement, whether or not the existing loan is satisfied and replaced by the new loan, and charging a fee. (10) Open-Ended Loans A lender shall not make any loan as an open-
  15. 15. Florida Mortgage Brokerage and Lending Act Rules and Regulations     11 ended loan in order to evade the provisions of this act unless such open-ended loans meet the definition in 12 C.F.R. s. 226.2(a)(20). (11) Recommendation of Default A lender shall not recommend or encourage default on an existing loan or other debt prior to and in connection with the closing or planned closing of a high-cost home loan that refinances all or any portion of such existing loan or debt. (12) Prohibited Door-To-Door Loans A high-cost home loan may not be made as a direct result of a potential or future lender or its representative offering or selling a high-cost home loan at the residence of a potential bor- rower without a prearranged appointment with the potential borrower or the expressed invita- tion of the potential borrower. This subsection does not apply to mail solicitations that may be received by the potential borrower. (13) Late Payment Fees A lender may not charge a late payment fee for a high-cost home loan except as provided in this subsection. A late payment fee: (a) may not be in excess of 5 percent of the amount of the payment past due. (b) may only be assessed for a payment past due for 15 days or more. (c) may not be charged more than once with respect to a single late payment. If a late payment fee is deducted from a payment made on the loan and such deduction causes a subsequent default on a subsequent pay- ment, no late payment fee may be imposed for such default. If a late payment fee has been imposed once with respect to a par- ticular late payment, no such fee shall be imposed with respect to any future payment which would have been timely and suffi- cient, but for the previous default. (14) Modification or Deferral Fees A lender may not charge a borrower any fees or other charges to modify, renew, extend, or amend a high-cost home loan or to defer any payment due under the terms of a high-cost home loan on a minimum of one modifica- tion, renewal, extension, or deferral per each 12 months of the length of the loan. HIGH-COST LOAN DISCLOSURES Chapter 494.00792 F. S. provides: (1) In addition to other disclosures required by law and in conspicuous type: (a) Notice to borrower. A lender making a high-cost home loan shall provide a notice to a borrower in substantially the following form: If you obtain this high-cost home loan, the lender will have a mortgage on your home. You could lose your home and any money you have put into it if you do not meet your obligations under the loan. Mortgage loan rates and closing costs and fees vary based on many factors, includ- ing your particular credit and financial circumstances, your employment history, the loan-to-value requested, and the type of property that will secure your loan. The loan rate and fees could also vary based upon which lender or broker you select. As a borrower, you should shop around and compare loan rates and fees. You should also consider consulting a quali- fied independent credit counselor or other experienced financial adviser regarding the rates, fees, and provisions of this mort- gage loan before you proceed. You should contact the United States Department of Housing and Urban Development for a list of credit counselors available in your area. You are not required to complete this agreement merely because you have received these disclosures or have signed a loan application. Borrowing for the purpose of debt consolidation can be an appropriate financial management tool. However, if you continue to incur sig- nificant new credit card charges or other debts after this high-cost home loan is closed and then experience financial dif- ficulties, you could lose your home and any equity you have in it if you do not meet your mortgage loan obligations. Remember that property taxes and home- owners’ insurance are your responsibility. Not all lenders provide escrow services for these payments. You should ask your lender about these services. Also, your payments on existing debts contribute to your credit rating. You should not accept any advice to ignore your regular pay- ments to your existing creditors. (b) Annual percentage rate A lender making a high-cost home loan shall disclose: 1. In the case of a fixed mortgage, the annual percentage rate and the amount of the regular monthly payment. 2. In the case of any other credit transac- tion, the annual percentage rate, the amount of the regular monthly payment and the amount of any balloon payment permitted under this section, a statement that the interest rate and monthly pay- ment may increase, and the amount of the maximum monthly payment based upon the maximum interest rate allowed pursuant to law.
  16. 16. 12     Module 1 (c) Notice to purchasers and assignees All high-cost home loans shall contain the following notice: Notice: This is a mortgage subject to the provisions of the Florida Fair Lending Act. Purchasers and assignees of this mortgage could be liable for all claims and defenses with respect to the mortgage which the borrower could assert against the creditor. (2) Timing of Disclosure (a) The disclosure required by this subsection shall be given not less than 3 business days prior to the consummation of the high-cost home loan. (b) New disclosures are required when, after disclosure is made, the lender making the high-cost home loan changes the terms of the extension of credit, including if such changes make the original disclosures inac- curate, unless new disclosures are provided that meet the requirements of this section. (c) A lender may provide new disclosures pur- suant to paragraph (b) by telephone, if: 1. The change is initiated by the borrower. 2. At the consummation of the high-cost home loan: a. The lender provides the disclosures in writing to the borrower. b. The lender and the borrower cer- tify in writing that the new disclosures were provided by telephone no later than 3 days prior to the consumma- tion of the high-cost home loan. (d) A creditor must disclose to any high-cost home loan borrower the rights of the bor- rower to rescind the high-cost home loan within 3 business days pursuant to 15 U.S.C. s. 1635(a) and shall provide appropriate forms for the borrower to exercise his or her right to rescission. The notice, forms, and provisions thereof must be in accor- dance with the requirements of 15 U.S.C. s. 1635(a). REGULATION OF THE FLORIDA FAIR LENDING ACT The Office of Financial Regulation and the Financial Services Commission are responsible for the adminis- tration and enforcement of The Florida Fair Lending Act. Duties include investigations, examinations, injunctions, and orders. Powers and Duties of the Commission and Office; Investigations; Examinations; Injunctions; Orders Chapter 494.00795, F.S. provides that the Commission and Office are responsible for the administration and enforcement of this act. The Commission may adopt rules pursuant to ss. 120.536(1) and 120.54 to imple- ment this act. The Commission may adopt rules to allow electronic submission of any forms, documents, or fees required by this act. The Office: may conduct an investigation of any person when- ever the Office has reason to believe, upon com- plaint or otherwise, that any violation of the act has occurred. any person having reason to believe that a provision of this act has been violated may file a written com- plaint with the Office setting forth the details of the alleged violation. may conduct examinations of any person to deter- mine compliance with this act. may bring action through its own counsel in the name and on behalf of the state against any person who has violated or is about to violate any provision of this act or any rule or order issued under the act to enjoin the person from continuing in or engag- ing in any act in furtherance of the violation. in any injunctive proceeding, the court may issue a subpoena or subpoenas duces tecum, requiring the attendance of any witnesses and the production of any books, accounts, records, and other documents and materials that appear necessary to the expedi- tious resolution of the application for injunction. may issue and serve upon any person an order to cease and desist and to take corrective action when- ever it has reason to believe the person is violating, has violated, or is about to violate any provision of this act, or any written agreement between the person and the Office. All procedural matters relat- ing to issuance and enforcement of such cease and desist orders are governed by the Administrative Procedure Act. whenever the Office finds a person in violation of this act, it may enter an order imposing a fine in an amount not exceeding $5,000 for each count or separate offense, provided that the aggregate fine for all violations of this act that could have been asserted at the time of the order imposing the fine shall not exceed $500,000. Any violation of this act shall also be deemed to be a violation of Chapter 494, Chapter 516, Chapter 520, Chapter 655, Chapter 657, Chapter 658, Chapter 660, Chapter 663, Chapter 665, or Chapter 667. The com- mission may adopt rules to enforce this subsection. Enforcement of the Florida Fair Lending Act Chapter 494.00796, F.S. provides: • • • • • • •
  17. 17. Florida Mortgage Brokerage and Lending Act Rules and Regulations     13 (1) Any person or the agent, officer, or other repre- sentative of any person committing a material vio- lation of the provisions of this act shall forfeit the entire interest charged in the high-cost home loan or contracted to be charged or received, and only the principal sum of such high-cost home loan can be enforced in any court in this state, either at law or in equity. (2) A creditor in a home loan who, when acting in good faith, fails to comply with the provisions of this act shall not be deemed to have violated this act if the creditor establishes that within 60 days after receiving any notice from the borrower of the compliance failure, which compliance failure was not intentional and resulted from a bona fide error notwithstanding the maintenance of proce- dures reasonably adapted to avoid such errors, the borrower has been notified of the compliance fail- ure, appropriate restitution has been made to the borrower, and appropriate adjustments are made to the loan. Bona fide errors shall include, but not be limited to, clerical, calculation, computer mal- function and programming, and printing errors. An error of legal judgment with respect to a per- son’s obligations under this section is not a bona fide error. (3) The remedies provided in this section are cumu- lative. CONCLUSION In conclusion, it is important to be aware of current rules and regulations governing the mortgage lend- ing business and the extent to which they affect daily practice. These rules and regulations apply to a wide range of topics, including licensure requirements, continuing education requirements, and penalties for violations of the rules. The Department of Financial Services is responsible for regulating the activities of mortgage brokers, mortgage brokerage businesses, mortgage lenders, and correspondent mortgage lend- ers by the use of Florida Statutes and the Florida Administrative Code and, when necessary, for impos- ing penalties on licensees found to be in violation. RESOURCES To access any of the required forms, go to www.flofr. com/licensing/MBlist.htm and select the appropri- ate license type. To access Chapter 494 online, go to www.leg.state.fl.us/Statutes/index.cfm?App_ mode=Display_StatuteURL=Ch0494/titl0494. htmStatuteYear=2006Title=-2006- Chapter%20494 To access the Florida Administrative Code, Rules 69V-40, go to www.flofr.com/licensing/Rules Statutes/Rule69V-40.htm
  18. 18. 14     Module 1 Transfer your answers to the space provided on the Answer Sheet. 1. In Chapter 494, an individual, partnership, corporation, trust, or other organization that possesses the power to direct the management or policies of a company is referred to as a: a. joint venturer. b. control person. c. principal broker. d. principal representative. 2. The most significant change to the Rules Regulation Mortgage Brokers by 2004 was the creation of which new Chapters? a. 40-69V F.A.C. b. 96V-40 F.A.C. c. 69V-40 F.A.C. d. 3D-40 F.A.C. 3. Which of the following is not a relevant change to Chapter 494 that became effective October 1, 2006? a. Elimination of the need to display individual, main and branch office licenses. b. Provision that applications are not deemed received until all required fees are received and authorizes disci- plinary action if fees are paid with a bad check. c. Provision that grounds for no disciplinary action when action is taken by other federal and state regulatory organizations located in or outside the State of Florida involving securities, insurance, real estate, and lending activities. d. Allows the Office to contract with a third party vendor to administer the mortgage broker test. 4. Which of the following is not a prohibited act per Chapter 494? a. To act as a mortgage lender in this state without a current, active license issued by the Office pursuant to 494.006-494.0077, F.S. b. To record a mortgage brokerage agreement or any other document, rendered by a court of competent jurisdic- tion, which purports to enforce the terms of the mortgage brokerage agreement. c. To pay a fee or commission in any mortgage loan transaction to any person or entity other than a mortgage brokerage business, mortgage lender, or correspondent mortgage lender, operating under an active license, or a person exempt from licensure under this chapter. d. In any matter within the jurisdiction of the Office, to knowingly and willfully falsify, conceal, or cover up by a trick, scheme, or device a material fact, make any false or fraudulent statement or representation, or make or use any false writing or document, knowing the same to contain any false or fraudulent statement or entry. 5. Audited financial statements of lenders must be prepared according to: a. U.S. generally accepted accounting principles. b. U.S. generally accepted auditing principles. c. U.S. generally accounted accepted principles. d. audited financials are not required by lenders once licensed. 6. Electronic filing of applications, renewals, and fees can be done by: a. mortgage brokers. b. mortgage brokerage businesses. c. mortgage lenders. d. all of the above. M O D U L E REVIE W E X ERCISES Use the exercise questions to review the module material. The answers are found on the bottom of the next page.
  19. 19. Florida Mortgage Brokerage and Lending Act Rules and Regulations     15 Transfer your answers to the space provided on the Answer Sheet. 7. A person is presumed to control a company if, with respect to a particular company, that person: a. is a director, general partner, or officer exercising executive responsibility or having similar status or functions. b. directly or indirectly may vote 10 percent or more of a class of voting securities or sell or direct the sale of 10 percent or more of a class of voting securities. c. in the case of a partnership, may receive upon dissolution or has contributed 10 percent or more of the capital. d. any of the above. ANSWERS: 1)b2)c3)c4)b5)a6)d7)d
  20. 20. 16     Module 1
  21. 21. © 2007 Bert Rodgers Schools of Real Estate, Inc. 17 Learning Objectives After completing this module, you should be able to: Credit Scores and Credit Scoring M O D U L E 2 1. Define the terms credit score and credit ­scoring. 2. List the consumer’s rights under the Fair Credit Reporting Act (FCRA) and the Fair and Accurate Credit Transaction Act (FACT ACT). 3. Discuss what counts in a credit score, what can be done to raise a credit score, and how to create one through the use of nontraditional credit. 4. List the entities that use credit scores as a tool to evaluate a borrower’s credit worthiness and how the credit score affects the terms offered. INTRODUCTION Making payments on time creates a solid credit rat- ing, but it takes time to build. However, getting into a bad credit situation can happen very quickly by pay- ing accounts late or not at all. If one of the accounts is a mortgage loan, the lender can foreclose on the property to recover their loss, and the consumer will no longer have a home. Who Uses Credit Scores? The 3 national consumer reporting companies sell the information in the report to creditors, insurers, employers, and other businesses that use it to evalu- ate applications for credit, insurance, employment, or renting a home. Since a credit report includes information on where the applicant has lived, how they pay their bills, and whether they have been sued, arrested, or filed for bankruptcy, all types of creditors pull credit reports and use credit scoring. Mortgage lenders use credit scores to help them evaluate a borrower’s request quickly and efficiently through automated means. Higher scores normally mean better interest rate and terms. In fact, the inter- est rate offered is normally directly related to the credit score. Insurance companies use credit scores to determine auto and home owner policy premiums. Car dealers, furniture stores, cell phone service companies, credit card companies, and landlords use credit scores. CREDIT SCORES When consumers apply for a mortgage loan today, the lender is looking for a certain minimum credit score to make an automated underwriting decision. A credit score is determined by a complex mathematical equation that evaluates the information contained in a consumer’s credit file. Myfico.com defines a credit score as: …a number generated by a statistical model which is used to objectively evaluate information that pertains to making a credit decision. Credit Bureaus Equifax, Experían, and TransUnion, are national credit reporting agencies that maintain credit reports in the United States and work independently of each other to gather information from businesses and update consumer credit profiles. Each bureau has a name for the score model they use. Experían uses the FICO score, created by Fair Isaac and Company. Equifax uses the Beacon score model. TransUnion uses the Empirica score model. Until 2005, the 3 major credit bureaus only provided these scores to lenders. That changed when the Fair and Accurate Credit and Transaction Act (FACT ACT), effective September 1, 2005 allowed con- sumers to receive once a year, upon request, a free copy of their credit report. Consumers can always receive a free copy of their credit report if they have been denied credit due to information contained in a
  22. 22. 18     Module 2 credit bureau within 60 days of being denied credit. The Equal Credit Opportunity Act (ECOA) requires that the creditor provide a notice disclosing the rea- son the loan was rejected. The Fair Credit Reporting Act (FRCA) requires the creditor to give the name, address, and phone number of the consumer report- ing company that supplied the information. www.annualcreditreport.com www.equifax.com www.experian.com www.transunion.com Credit Scoring This process of evaluating past credit performance to predict future credit performance is called credit scoring. Credit scores for mortgage purposes range from 300 – 850. Higher credit scores are indicative of better credit performance and lower scores indicative of possible default in the future. Since it is based on statistics and real data, it is more reliable than sub- jective methods as it treats each subject objectively. Under the ECOA, a credit scoring system may not use race, sex, marital status, national origin, or reli- gion as factors. The ECOA states that a person cannot be denied credit or have credit terminated because of their age. However, creditors are allowed to use age in a properly designed system but must give equal weight to elderly applicants. Consumer Credit Rights The federal FCRA promotes the accuracy, fairness, and privacy of information in the files of consumer reporting agencies. Consumer reporting agen- cies include credit bureaus and specialty agencies. Specialty agencies include agencies that sell informa- tion about check writing histories, medical records, and rental history records. Consumers’ rights under the FCRA include: Consumers must be told if information in their credit file has been used against them. Consumers have the right to know what is in their file. Consumers have the right to ask for a credit score. Consumers have the right to dispute incomplete or inaccurate information. Consumer reporting agencies must correct or delete inaccurate, incomplete, or unverifiable infor- mation. Consumer reporting agencies may not report out- dated negative information. Access to the file is limited to people with a valid need. Written signed disclosure by the consumer autho- • • • • • • • • rizing disclosure for an employer to access the file is required. Consumers can limit prescreened offers by opting out. Consumers can seek damages from violators. Identity theft victims and active duty military per- sonnel have additional rights. The Federal Trade Commission (FTC) handles con­­­sumer complaints. Their contact information is below: Phone: (877) -FTC-HELP (382-4357) Mail: Federal Trade Commission CRC-240 Washington, D.C. 20580 Online complaint form: https://rn.ftc.gov/ pls/dod/wsolcq$.startup?Z_ORG_CODE= PU01 What Counts in a Credit Score? When a credit score is provided, 4 reason codes are also provided to explain the scoring decision. It also gives insight on how the score may be improved. Each bureau places different weight on different fac- tors. Some look more heavily upon installment loans and others on collections. If a credit report is used in making a decision to accept or reject a mortgage loan, then the customer must be provided a National Credit Score Disclosure. The National Credit Score Disclosure provides the reason codes that were used most heavily in determining the score. See a sample disclosure in Exhibit I. FICO Score. According to FICO, a consumer’s credit score is composed of 5 factors each weighted differently. 1. 35% of the FICO score is determined by how the consumer pays their credit accounts. Late pay- ments, bankruptcies, and other negative items con- tribute negatively to the score. 2. 30% of the FICO score is determined by how much is owed on all outstanding accounts, the number of accounts, and how much available credit is being utilized. The more owed, the lower the score. 3. 15% of the FICO score is determined by the length of the credit history. However a short credit history with successful financial management will reflect positively in the score. 4. 10% of the FICO score is determined by open- ing new accounts. Too many inquiries that do not result in the extension of credit will reflect nega- tively in the score. Interest rate shopping should be done in a short period of time to minimize lower- ing the score. • • •
  23. 23. Credit Scores and Credit Scoring     19 Exhibit I: National Credit Score Disclosure Form Source: Calyx
  24. 24. 20     Module 2 5. 10% of the FICO score comes from having a mix of credit like credit cards, a mortgage, and an install- ment loan. This chart shows how the Fair Isaac Corp. values the various parts of your credit management to determine your credit score. Figure 2.1 What Counts in a Credit Score? Source: Fair Isaac Corp., www.myfico.com How Can a Credit Score be Improved? Credit scores change as new information is reported in the consumer’s credit file. In order to improve the score, a consumer should consider: paying bills on time. keeping balances low on credit cards in relation to available credit. paying down revolving debt. applying for new credit only when necessary. if any payments have been missed, get current and stay current. The credit file should be checked periodically to be certain there are no errors and to help guard against identity theft. If an identity thief opens an account in your name and does not pay the bill, the bad credit could be reported under your name. If any of the information is incorrect, then under the FCRA, both the consumer reporting agency and the creditor are responsible for correcting inaccurate or incomplete information. Once the consumer sends written proof of the mistake to the credit reporting agency, the agency has 30 days to investigate the information. The credit reporting agency must delete the con- tested information when the agency does not receive a response from the creditor or if the creditor is out of business and the information cannot be verified. Under the FCRA, consumer reporting agencies must correct or delete unverifiable, inaccurate, or incom- plete information within 30 days of notification by the consumer. Negative information or bad credit will be reported for 7 years. Bankruptcies and judgments will be reported for 10 years. Borrowers who do not have traditional credit accounts • • • • • like a credit card, a car loan, or mortgage are consid- ered unscoreable at the bureaus. Because of the lack of traditional credit reporting, the model cannot provide a numerical determination. These borrowers may be placed into subprime loans with higher rates and fees because the lender cannot determine the risk associ- ated with lending to this borrower. Pay Rent Build Credit Pay Rent Build Credit, Inc. (PRBC) is a consumer reporting agency that collects, stores, scores, and reports bill payment data for permissible purposes under the FCRA. Their website is devoted to help- ing people develop credit scores based on alterna- tive credit. Their philosophy advocates that Payment Reporting Builds Credit.SM It is the first credit bureau to give consumers and small businesses the tools to demonstrate their creditworthiness without the need to go into debt (www.prbc.com ). In addition to receiving payment data from creditors and financial institutions’ bill payment services, PRBC has partnered with the National Credit Reporting Association to verify trade line accounts and up to 3 years worth of prior payments that are reported directly by consumers to PRBC. Lenders can purchase a PRBC ReportSM depicting a consumer’s bill payment history either on a stand- alone basis, or merged with Equifax, Experían, and TransUnion credit reports. Each report is accompa- nied by a PRBC Bill Payment ScoreSM (BPSSM ). PRBC Reports and the BPS are used in the absence of, or as a supplement to a traditional credit report, to gain a more complete and accurate risk assessment of an applicant. A PRBC Report may also be used as a nontraditional mortgage credit report which exceeds secondary market standards for documenting cred- itworthiness. PRBC does not charge consumers or small businesses a fee to enroll in the service or to view their own payment data at any time. The main objec- tive is to automate the mortgage application process for hard-to-score borrowers so they may qualify for better loan products and pricing. VantageScoreSM In 2006, the 3 national repositories introduced the jointly developed new credit score, VantageScoreSM designed to simplify and enhance the credit process for both consumers and credit grantors. VantageScoreSM can provide consumers and businesses with a highly predictive, consistent score that is easy to understand. Scores range from 501 to 990. with higher scores indicative of lower risk. A type of report card has been created with grades A to F.
  25. 25. Credit Scores and Credit Scoring     21 A = 901 – 990 B = 801 – 900 C = 701 – 800 D = 601 – 700 F = 501 – 600 VantageScoreSM is able to more effectively provide predictive scores on thin-file consumers—those with little consumer credit—which is useful in risk man- agement. The VantageScoreSM is determined by: Payment history 32%: Have you consistently paid your accounts in a timely manner? Utilization 23%: How much of the total credit available to you are you currently using? Balances 15%: What is the total of your current and delinquent account balances? Depth of credit 13%: How long is your credit his- tory and do you have a mix of credit types? Recent credit 10%: How many recently opened credit accounts and credit inquiries do you have? Available credit 7%: What is the total amount of credit to which you currently have access? Figure 2.2 Determining Your VantageScoreSM Source: www.vantagescore.com/consumerinfo.html PRESCREENING FOR MORTGAGE PRODUCTS SOLICITATION Prescreening is a tool used by institutions to solicit pre-identified, potential customers for mortgage products. The 3 national repositories compile lists of new customers, sometimes called a trigger list, based on specific criteria provided by the institution. Once someone’s credit has been pulled, an inquiry appears. Then, the bureau knows that the customer might be looking for a mortgage. This trigger, or customer’s name, is then sold to the institution be it a mortgage broker, lender, or lead generation company. The insti- tution then sends the customer a prescreened offer. Although prescreening is allowed under the FCRA, there is some concern about lead generation compa- • • • • • • nies obtaining credit profiles. The intention of pre- screening is supposed to be able to offer a firm offer of credit. But, just having a credit score is not enough to obtain a mortgage other factors to be considered include income and property acceptability. Therefore, lead generation companies cannot make offers of credit and may contribute to identity theft if the credit profiles wind up in the wrong hands. Conclusion Using credit wisely can enrich the consumer giv- ing him or her more buying power at lower interest rates, and having more offers of credit extended. For those who do not pay their bills on time and have negative items reported on their credit report, financ- ing becomes increasingly more difficult. Just like in school, good grades count. The better your grades, the better your job opportunities. A higher credit score brings better offers and terms. RESOURCES The Consumer Division of Fair Isaac www.myfico.com Order your free credit report from all three bureaus each year at www.annualcreditreport.com Equifax www.equifax.com 1-800-685-1111 Experían www.experian.com 888-397-3742 TransUnion www.transunion.com 1-800-916-8800 Federal Trade Commission’s Consumer Complaint Forms https://rn.ftc.gov/pls/dod/wsolcq$.startup? Z_ORG_CODE=PU01 Help consumers develop credit scores based on alter- native credit www.prbc.com Obtain a tri-bureau generic credit scoring system www.vantagescore.com/consumerinfo.html The Federal Trade Commission (FTC) handles consumer complaints. Their contact information is below: Phone: (877) -FTC-HELP (382-4357) Mail: Federal Trade Commission CRC-240 Washington, D.C. 20580 Pay Rent Build Credit, Inc. (PRBC) www.prbc.com Calyx Software www.calyxsupport.com
  26. 26. 22     Module 2 True or False 1. The best way to get a free copy of your credit report is to file a request with the FTC. T F 2. According to the FACT ACT, consumers are allowed to receive a free credit report once per year. T F 3. According to FICO, payment history is the most heavily weighted category in determining a credit score. T F 4. According to VantageScoreSM the most heavily weighted category that determines a credit score is credit utilization. T F 5. Paying bills on time and keeping the balances low on credit cards contribute positively to credit scores. T F 6. The 3 national credit reporting agencies compile trigger lists. T F 7. The Equal Credit Opportunity Act states an applicant can be denied credit based on age. T F Multiple-Choice 1. __________ promotes the accuracy, fairness, and privacy of information in the files of consumer reporting agencies. a. ECOA b. FCRA c. FACT ACT d. TILA 2. The process of evaluating past credit performance to predict future credit performance is called: a. credit scaring. b. credit rating. c. credit scoring. d. credit evaluation. 3. Consumers who have thin credit files can now build a credit profile and have a credit score developed by which company? a. Pay Rent Build Highway b. Pay Rent Build Credit c. Pick Rates Buy Cars d. Pick Rates Better Credit 4. Which of the following creditors use credit scores? a. mortgage lenders b. cell phone providers c. landlords d. all of the above 5. Per the Fair Credit Reporting Act (FCRA), a credit bureau has _____ days to investigate an inquiry of inaccurate or incomplete information. a. 10 b. 15 c. 30 d. 60 ANSWERS: TrueorFalse:1)F2)T3)T4)F5)T6)T7)FMultipleChoice:1)b2)c3)b4)d5)c M O D U L E REVIE W E X ERCISES Use the exercise questions to review the module material. The answers are found on the bottom of the page.
  27. 27. © 2007 Bert Rodgers Schools of Real Estate, Inc. 23 Learning Objectives After completing this module, you should be able to: Exotic and Nontraditional Mortgages M O D U L E 3 1. Define each of the terms in the glossary. 2. Discuss the history of how these loans have evolved. 3. Identify the type of borrowers these products should be marketed to. 4. Explain why these products are often costly and complex. GLOSSARY AND ACRONYMS 1st adjustment cap: The percentage the interest rate will change after its initial fixed period. Adjustable rate mortgage (ARM): A mortgage in which the interest rate is not fixed and is adjusted periodically based on a predetermined index. This results in changes to the monthly payment amount, the outstanding mortgage balance, and/or the mort- gage term. Adjustment period: The number of months the interest rate is fixed between each interest rate adjust- ment for an adjustable rate mortgage. Amortization: Repayment of a mortgage in periodic installments of principal and interest that will pay off the mortgage at the end of the mortgage term. Deferred interest: The dollar amount that is added to the original amount borrowed because the monthly mortgage payment is insufficient to cover the inter- est costs. This is a common feature in pay-option ARM’s. Equity: The difference between the property’s value and the owner’s indebtedness. Index: A rate set by market forces and published by a neutral third party. The index fluctuates up and down due to market factors. Lenders use the index to deter- mine the interest rate on an adjustable rate mortgage by adding it to the margin. Some examples of indexes are the prime lending rate, 1-, 3-, or 5- year U.S. Treasury security yields (CMT), the London Inter Bank Offering Rate (LIBOR), Certificate of Savings Index (COSI), 11th District Cost of Funds Index (COFI), and 12-Month Treasury Average (MTA). Indexed rate: The lender uses the published rate of the index and adds it to a fixed margin to determine the current interest rate on an adjustable rate mortgage. Initial fixed period: The number of months the loan will be fixed at the initial interest rate. Interest-only mortgage (I/O): A mortgage where the monthly payment does not include any repay- ment of principal for a predetermined, fixed period of time. The payment consists of interest only. The payment can be fixed for the interest-only period or the payment can adjust (increase) during the interest- only period. During the interest-only period, the loan balance remains unchanged. Life cap: The maximum percentage that the initial interest rate can increase or decrease during the life of the loan. Margin: The amount a lender adds to the index on an adjustable rate mortgage to establish the new adjusted interest rate. The margin when added to the index equals the fully indexed note rate. Negative amortization: When the monthly mort- gage payments do not cover all of the interest. The interest portion that is not covered is added to the principal balance. The borrower owes more than originally borrowed. Nontraditional mortgage: A mortgage where the borrower pays only the mortgage loan interest or possibly an even lesser amount of the interest that is due each month resulting in deferred interest and negative amortization.
  28. 28. 24     Module 3 Payment cap: The maximum percentage that the interest rate can increase or decrease for each adjust- ment period. Normally, it is 7.5% more than the previous month’s payment. This keeps the payment artificially lower than interest rate caps which limit how high or low the interest rate can adjust. Pay-option adjustable rate mortgage (pay-option ARM): An adjustable rate mortgage with the flex- ibility of making several different monthly mortgage payments each month based on the borrower’s cash flow. The borrower can pay the minimum payment, the interest only payment, or the fully amortized note rate payment. Prepayment penalty: A charge the lender makes when a mortgage is repaid before a certain period of time elapses or when the borrower repays a certain additional amount of principal before a certain period of time elapses. With soft prepayment penalties, if the borrower sells the home during the prepayment period, then no penalty is assessed but if the borrower refinances, a penalty is assessed. With hard prepay- ment penalties, whether the house is sold or refinanced during the penalty period, a penalty will be assessed. The penalty also applies if the borrower repays more than 20% of the principal in any 12-month period. Principal: The amount of money borrowed or the outstanding balance of a loan, not including interest. The portion of the monthly payment that is used to reduce the loan balance. Recast: Increasing the monthly mortgage payment to be computed on the fully indexed rate when the loan balance reaches the maximum negative amortization. The loan can be re-amortized several times through- out the term. As this occurs, the increased monthly payment overrides the monthly amount set by the payment cap. Traditional mortgage: Mortgages that require the borrower to repay part of the principal, in addition to paying interest on the money borrowed. INTEREST-ONLY AND PAY-OPTION ADJUSTABLE RATE MORTGAGES Interest-Only Mortgage Normal home appreciation is around 6% per year. However, the past few years have seen appreciation at 20% levels or higher but incomes have not kept pace. Interest-only mortgages (I/O) help people purchase their first home because of the lower initial monthly payment of interest only that allows consumers to qualify with a lower monthly payment. I/O’s are for borrowers who want a lower initial monthly pay- ment, and have great confidence that they will be able to make larger payments in the future when the I/O period expires. The I/O payment is normally fixed for a period of time lasting anywhere from the first 3 years to 10 years. After the fixed interest-only period, the monthly pay- ment will increase even when the interest rate is fixed for the life of the loan. For example, if the mortgage is a 30-year fixed rate at 6.25% with interest only for the first 10 years of the mortgage, then the borrower’s monthly payment will be lower in the first 10 years and increase in years 11–30. If the borrower pays $200,000 for the home and puts $10,000 down, or a 5% down payment, then $190,000 will be financed. The monthly mortgage payment in years 1–10 will be $989.58 ($190,000 x 6.25% ÷ 12). At the end of 10 years, the borrower still owes the same $190,000 they borrowed. Then, for the remaining term of the mortgage, the borrower’s monthly payment will be increased to $1,388.76 so the mortgage will be paid in full (principal and interest) at the end of 30 years. See Table 3.1 Table 3.1: Payment Schedule for 10 Years Interest Only, 30 Years Fixed # of payments Interest rate Monthly payment Mortgage balance 120 6.25% $989.58 $190,000 240 6.25% $1,388.76 $0.00 Adjustable Rate Mortgage (ARM) Let’s say that the interest rate in the above example was not fixed but was a 5/1 adjustable rate mortgage (ARM) with 5 years of interest only. With an ARM, the interest rate fluctuates according to a predeter- mined index plus basis points, called a margin. A basis point is 1/100th of 1%. A standard margin is 275 basis points or 2.75%. The higher the margin is, the greater the yield to the lender. The new interest rate at adjustment is the current index plus the mar- gin. For example, if the index is 5% and the margin is 2.75%, then the new indexed rate is the sum of 5% and 2.75% which equals 7.75%. Lenders use different indexes to base the adjustments to the interest rate. Some indexes move more slowly than others. Some of the more common indexes used with these products are the Prime Lending Rate, the London Inter Bank Offering Rate (LIBOR), the Cost of Savings Index (COSI), the Cost of Funds Index (COFI), and the 12- Month Treasury Average (MTA). The MTA is a relatively new index and is the 12-month average of the monthly average yields of U.S. Treasury securi- ties. The current rate of these indexes can be found in the business section of the local newspaper, in the Wall Street Journal, or online at www.wsj.com.
  29. 29. Exotic and Nontraditional Mortgages     25 Most ARMs have interest rate caps per adjustment and life of loan caps. A cap limits the increase or decrease per adjustment. For example, the standard 5/1 LIBOR ARM has 2/6 caps, meaning the inter- est rate cannot increase or decrease more than 2% per adjustment and no more than 6% for the life of the loan. The 5/1 LIBOR ARM is fixed for the first 5 years of the loan and then adjusts once annually based on the then going LIBOR index added to the fixed margin that was determined at the onset of the mort- gage. See Table 3.2, which assumes the worst case sce- nario in the interest rate adjusting. Some indexes move slower than others. A faster mov- ing index will result in a higher payment at adjustment time. Table 3.3 shows the interest rate comparison of the different indexes used. Traditional vs Nontraditional Mortgages With traditional mortgages the borrower’s payment includes principal and interest and at the end of the loan term, the loan will be paid off or extinguished. These are considered fully amortizing loans. Lenders have put a spin on different amortization types and have caused some confusion with detrimental conse- quences for unsophisticated borrowers. Even some mortgage brokers/originators do not fully understand the product they are marketing. They know the lower monthly payment helps them qualify more borrowers for more loans, which translates into a higher income for the mortgage broker/originator. For example, if the borrower chose a 30-year fixed rate mortgage at 6.25%, then their monthly mortgage payment would be $1,170.40 for all 360 payments (12 payments per year x 30 years = 360 payments). The monthly pay- ment can be calculated by using a financial calculator, and can also be done online at www.fool.com/calcs/ calculators.htm or www.bankrate.com or by multi- plying the loan amount by a numeric factor that pays the loan off at the end of 30 years ($190,000 x 6.16 {30 year factor}). See Table 3.4. A fixed rate mortgage is the best product for someone who wants certainty in their payment or is on a fixed income, like a retired borrower. Nontraditional mortgages are normally ARM’s paired with amortization, without amortization (I/O), and with negative amortization. They allow borrowers different amortization and different payment options. A payment option adjustable rate mortgage (pay- option ARM) is based on the MTA index and will require the borrower’s first 3 months of payments to be at a low, fixed rate or just for the first month at a low, fixed rate. Then in the fourth month (if fixed Table 3.2: Payment Schedule for 5 Years of Interest Only, 5/1 LIBOR Arm Index, Start Rate = 6.00%, Margin = 2.75% # of payments Interest rate Monthly payment Mortgage balance 1st adjustment cap 2.00% 60 6.00% $ 950.00 $ 190,000 1st change 60 months 12 8.00% $1,466.45 $187,512.70 Adjustment cap 2.00% 12 10.00% $1,720.22 $185,532.20 Adjustment period 12 months 275 12% $1,982.53 $ 1,966.24 Life Cap 6.00% 1 12% $1,985.90 $ 0.00 Table 3.3: Comparison of Common Indexes from Today, a Month Ago, And A Year Ago Index Today as of 2/26/07 1 month ago 1 year ago 1 year CMT 5.05% 5.06% 4.74% 3 year CMT 4.73% 4.79% 4.71% 5 year CMT 4.69% 4.75% 4.66% 6 month LIBOR 5.39% 5.39% 4.94% Prime lending rate 8.25% 8.25% 7.50% 11th District COFI 4.396% 4.396% 3.624% 12-MTA 4.983% 4.983% 4.011% Table 3.4: PAYMENT SCHEDULE FOR 30 YEAR FIXED RATE AT 6.25% # of Payments Interest Rate Monthly Payment Mortgage Balance 360 6.25% $1,170.40 $0.00
  30. 30. 26     Module 3 Table 3.6: Partial Amortization Schedule through year 12 for Option 2 Year Total Payments Principal Paid Interest Paid Ending Principal Balance $190,000.00 1 $14,724.96 $0.00 $14,724.96 $190,000.00 2 $14,724.96 $0.00 $14,724.96 $190,000.00 3 $14,724.96 $0.00 $14,724.96 $190,000.00 4 $14,724.96 $0.00 $14,724.96 $190,000.00 5 $14,724.96 $0.00 $14,724.96 $190,000.00 6 $14,724.96 $0.00 $14,724.96 $190,000.00 7 $14,724.96 $0.00 $14,724.96 $190,000.00 8 $14,724.96 $0.00 $14,724.96 $190,000.00 9 $14,724.96 $0.00 $14,724.96 $190,000.00 10 $14,724.96 $0.00 $14,724.96 $190,000.00 11 $18,717.60 $4,137.52 $14,580.08 $185,862.48 12 $18,717.60 $4,469.82 $14,247.78 $181,392.66 $190,000.00 x 7.1523 (30 year factor for 7.75%) = $1358.95 (loan amount times factor equals monthly payment that will pay off the amount borrowed plus interest at the end of the term) Notice how the balance owed does not decrease until year 11. This is just an example through year 12. Also, notice that $14,724.96 ÷ 12 = $1227.08 for first 3 months) or the second month (if fixed for only first month), the borrower can choose to make different payment arrangements. The borrower has 3 options. Option 1. Pay the principal and interest due that will pay off the loan at the end of the term being 15, 30, or 40 years. This is considered a traditional mortgage pay- ment where the principal balance decreases each month after making a payment. Also called amortization. Option 2. An interest-only (I/O) payment. This pay- ment arrangement does not decrease the amount owed but does allow the borrower to make a lower monthly payment. The interest only payment is calculated by multiplying the mortgage amount by the fully amortizing interest rate and dividing by 12. The minimum monthly pay- ment is normally .55 multiplied by the fully amortiz- ing payment or the payment is computed by using 3% less than the fully amortizing note rate to determine the payment. Option 3. Pay a minimum payment which is less than the amount of interest due for the month and does not reduce the amount borrowed and the difference will be added to the amount borrowed increasing the principal balance and causing negative amortization. Payment caps contribute to keeping the payment low, adding more deferred interest to the amount owed. Example: In our same illustration of financing $190,000, the borrower chooses a one-month MTA pay-option ARM with an introductory rate of 1% and margin of 2.75%. The borrower chooses option 3 from above to make a minimum payment for the first 12 months. The minimum payment is calculated by amortizing the loan over 30 years at the start rate and loan amount. The minimum monthly payment would be only $611.12. The I/O payment would be $1,227.08, which is calculated on the fully amortizing note rate of 7.75%. The 30-year fully amortizing pay- ment would be $1,358.95. See Table 3.5. Table 3.5: Payment Options for Pay-option Arm Minimum payment $611.12 OPTION CHOSEN I/O payment $1,227.08 30 year fully amortizing payment $1,358.95 The monthly payment of $611.12 is computed by amortizing the amount borrowed over the loan term at the initial interest rate. The payment takes into account the current index of the MTA and the fixed margin of 2.75%. Assume that the MTA index is 4.98% in our example. $190,000.00 x 7.75% ÷ 12 = $1227.08 (loan amount times interest rate divided by 12 to determine monthly interest portion). If the interest only period is for 10 years, then the amount borrowed remains the amount owed for 10 years. See Table 3.6.
  31. 31. Exotic and Nontraditional Mortgages     27 The payment of $1,227.08 is fixed for 10 years while your mortgage payments are interest only. After 10 years of interest only payments, your monthly payment will increase to $1,559.80. This will pay off the loan balance in full after a total of 30 years. See Table 3.7. The worst-case scenario making minimum payments with a monthly payment cap increase of 7.5% per year is shown in Table 3.8. Table 3.8: Making Minimum Payments Worst-Case Scenario Monthly Payment Balance owed Year 1= $611.12 $197,500.00 Year 2= $656.95 = ($611.12 x 7.50%) $204,341.56 Year 3= $706.23 = ($656.95 x 7.50%) $209,000.00 Year 4= $759.19 = ($706.23 x 7.50%) $209,000.00 Year 5= $816.13 = ($759.19 x 7.50%) $209,000.00 During the first year of the mortgage, $615.96 per month is the amount of negative amortization that gets added to the principal balance. $615.96 is the dif- ference between the I/O payment and the minimum payment. $1,227.08 - $611.12 = $615.96. So, at the end of the first year, the borrower’s principal unpaid balance would be more than $197,500! With every successive year of making only minimum monthly payments, the principal unpaid balance goes up even higher until the maximum limit specified in the mort- gage. If it was 110%, then once the principal unpaid balance reaches $209,000 ($190,000 x 110%), the mortgage must be recast, that is re-amortized, and the customer’s monthly payment will be increased to be able to pay off the loan at the end of the term. This increased payment can be higher than the payment caps allow. This normally happens in increments of every 5 years. If the borrower defers payment of interest, then the outstanding mortgage amount could exceed the value of the borrower’s home. This may affect their ability to refinance their loan or sell their home since they will owe more than what the home is worth. This is exactly what the current real estate market is experiencing this year. Home values have remained flat and in some areas actually have decreased. A borrower who took out a loan like this who wants to sell right now might find that he or she needs to bring money to the closing, depending upon how much negative amortization has accrued. Selling a Home with a Loss of Equity In the previous example, at the end of the first year the borrower now owes more than $197,500 and decides he wants to sell. However, values have gone down and the home is now only worth $195,000, although he paid $200,000. He has stripped himself of his equity. Equity is the difference between the indebtedness on the property and what it is worth. With closing costs and payment of a real estate sales commission, this borrower would need over $10,000 to get it sold. Borrowers who take out these types of loans are bank- ing on the fact that they will be making more money in the future and the home will appreciate in value, thereby counteracting the amount of the negative amortization that has accrued. If one or both of these situations does not occur, the borrower will be in seri- ous trouble if he or she can not make the monthly payment. The home could be lost in foreclosure. Also, these loans may come with 1, 2 or 3, year prepay- ment penalties. A prepayment penalty is an additional fee the lender charges if the loan is paid off or refi- nanced within a predetermined period of time from the loan’s inception. The penalty is sometimes equal to 6 months of interest payments. In this example, the penalty would equal $7,362.48 ($1227.08 x 6). Note that in the examples above, the loan with the Table 3.7: Interest Only Mortgage Summary for Option 2 Payments 120 monthly payments of $1,227.08 240 monthly payments of $1,559.80 Loan amount $190,000.00 Interest rate 7.750% Interest only term 10 years Total Term (Including interest only period) 30 years Total payments $520,041.80 Total interest paid $331,602.81
  32. 32. 28     Module 3 least amount of interest paid is the 30-year fixed rate mortgage at 6.25%. See Table 3.9. Table 3.9: Interest Cost Comparison of 30 Year Fixed Rate 10 Year I/O Monthly payment Interest paid over life of loan Total paid over life of loan $1,170.40 $231,344.00 $421,344.00 30 yr fix $989.58 (1st 10 yrs) $262.052.00 $452,052.00 10 years I/O $1,170.40 x 360 = $421,344 (total paid over life of loan) - 190,000 (original loan amount) $231,344 (interest paid) 10 year interest only 30 year fixed at 6.25% $989.58 x 120 = $118,749.60 (interest) $1,388.76 x 240 = $333,302.40 (principal and interest) $190,000.00 (original loan amount) $143,302.40 (interest) $118,749.60 + $143,302.40 = $262,052. There is $30,708 ($262,052.10 - $231,344) more paid in interest charges when the borrower chooses the 10 year interest only option. If the borrower has the pay- option ARM, then the additional interest costs are even higher. We saw that with the negative amorti- zation loan that allows for 110% negative amortiza- tion. At the end of just 5 years, someone who borrows $190,000 already owes over $209,000. The Federal Reserve Board has prepared a pamphlet entitled Interest-Only Mortgage Payments and Payment- Option ARMs-Are They for You? There is a lot of infor- mation on these products and what to ask about and what to beware of. It is a great tool for you to pro- vide your customers to help them better understand these products. There is a mortgage shopping work- sheet that can be used to compare products for your customers. The pamphlet and the worksheet can be downloaded in PDF format at www.federalreserve.gov/pubs/mortgage_ interestonly/default.htm Other brochures to help consumers include: Specialty (Nontraditional) Mortgages: What Are the Risks and Advantages?; and Traditional Mortgages: Understanding Your Options. They can be downloaded at the follow- ing site: www.realtor.org/housopp.nsf/pages/ mortgages?OpenDocument WHO SHOULD APPLY FOR AN INTEREST ONLY MORTGAGE AND A PAY-OPTION ARM? Although these loans are risky to the unsophisticated borrower, they can be marketed to the following types of borrowers. Individuals: whose income will increase in the future. Examples include a doctor or lawyer who just finished school and is still paying off student loans but in the future their incomes should go up considerably, allow- ing them to devote more of their income to an increased mortgage payment. who have a lot of equity in their home now and can use the difference in the payment they are not mak- ing to apply to another investment. who are paid irregularly either through commis- sions or seasonal earnings. They can devote more of their earnings to the payment in higher-income producing months or pay only the minimum in lower-income producing months. WHO SHOULD NOT APPLY FOR AN INTEREST ONLY MORTGAGE OR A PAY- OPTION ARM? Borrowers who are not careful could wind up in a bad financial situation in the later years of their life. The following should not apply for these types of prod- ucts. Individuals: who will not be able to make increased payments in the future. An example would be someone who will be retiring in the next 10 years. Their income will become fixed at a lower amount and they will not be able to afford higher payments. in a situation where the value of the home will not keep pace with the escalating unpaid principal bal- ance due to negative amortization caused by mak- ing minimum monthly payments. WHY ARE THESE LOANS COSTLY AND COMPLEX? We saw with the standard 30-year fixed rate mortgage that the borrower pays back a little over the amount borrowed at the end of the term. With the pay-option ARM, the borrower owes more than 110% of what was borrowed plus interest in just 5 years by making the minimum monthly payment. Many borrowers do not realize that by paying interest only, the balance on the mortgage does not decrease or increase. The only way the borrower may gain any equity in the home is when values in the neighborhood appreciate. • • • • •

×