Overview
This lecture covers alternative loan arrangements in real estate, focusing on adjustable rate mortgages (ARMs), graduated payment loans, buydowns, and other specialized loan types, their features, and implications for borrowers and lenders.
Fixed-Rate vs. Alternative Loans
- Fixed-rate loans have constant payments, are easy to budget, but can be problematic during high inflation.
- Alternative financing helps buyers qualify when fixed-rate loans are unaffordable and shift some risk to the borrower.
- Common alternatives include adjustable rate loans, graduated payment loans, buydown loans, shared appreciation, and growing equity loans.
Legal Implications for Licensees
- Licensees should assist but not give legal advice in alternative financing.
- Attorneys must be involved due to complex legal and financial risks.
Adjustable Rate Mortgages (ARMs)
- ARMs have interest rates that adjust periodically based on a financial index.
- Key features: adjustment period (often annual), index (e.g., Treasury Bill rate, LIBOR), margin/spread, and caps on adjustments.
- Caps limit rate/payment changes per period and over the loan’s life.
- Negative amortization can occur but is often limited or excluded.
- Other features: mortgage insurance (if LTV > 80%), prepayment options, due-on-sale clauses, conversion to fixed-rate, and recouping missed rate increases.
- Federal law requires detailed ARM disclosures to borrowers.
- Lenders qualify borrowers using housing expense and total obligations ratios, usually calculated at the maximum first adjustment rate.
FHA and ARM Programs
- FHA Section 251 ARM uses a one-year Treasury index, 30-year term, 1% annual cap, 5% lifetime cap, and no negative amortization.
Graduated Payment Mortgages (GPM)
- GPMs start with lower payments, increasing annually during the gradation period, then level off.
- Negative amortization occurs initially but ends after gradation, then payments are fixed.
- FHA Section 245 A GPM offers plans with various annual increases and gradation periods.
Buydown Loans
- Buydowns lower payments temporarily or permanently by providing upfront funds.
- Permanent buydowns reduce the contract interest rate with discount points.
- Temporary buydowns (level or graduated) use upfront escrow to subsidize payments.
- Secondary market guidelines limit buydown amount, period, and payment increases.
- Qualification standards differ by agency, often with stricter ratios for temporary buydowns.
Other Loan Types
- Fixed-rate loans with balloon payments require a large final payment after a set term.
- Interest-only loans pay only interest, with the principal due at the end.
- Growing Equity Mortgages increase monthly payments to pay off the loan faster.
- Shared Appreciation Mortgages (SAM) split property appreciation between lender and borrower in exchange for a lower rate.
- Reverse-annuity loans pay the owner monthly, with repayment required later, often by selling the property.
Key Terms & Definitions
- ARM (Adjustable Rate Mortgage) — A loan with an interest rate that changes periodically based on a market index.
- Negative Amortization — When loan payments are insufficient to cover interest, increasing the principal balance.
- GPM (Graduated Payment Mortgage) — Loan with initially low payments that increase over time.
- Buydown — Upfront funds used to lower mortgage payments temporarily or permanently.
- Balloon Payment — Large final payment due at the end of a loan term.
- Growing Equity Mortgage (GEM) — Fixed-rate loan with increasing payments to speed up payoff.
- Shared Appreciation Mortgage (SAM) — Lender receives a share of property appreciation.
- Reverse-Annuity Loan — Lender pays borrower regularly, to be repaid when property is sold or after a set time.
- Margin/Spread — Percentage added to the index to set the ARM’s interest rate.
- Caps — Limits on how much rates or payments can increase at adjustment or over the loan’s life.
Action Items / Next Steps
- Review specific FHA and agency guidelines for each loan type.
- Stay updated on current mortgage market rates, terms, and qualification standards.
- Consult qualified attorneys when advising on or arranging alternative loan agreements.