Friday, May 22, 2009
In this post, Real Estate Attorney Keith Schumann discusses and defines some of the basics about obtaining a mortgage to purchase your co-op or condo. I recommend speaking with a mortgage professional to my new customers at the very start of their search. Mortgages are complex products which deserve careful consideration. Customers need to fine tune their understand of monthly costs, alternative scenarios, and properly target a price range for their purchase. Your real estate broker, mortgage professional, Attorney and CPA are all advisers who can help you to understand them and their tax benefits for your particular situation. It is always a good idea to ask your lender for a pre-qualification letter; which is usually done as a complimentary service. This is not the same as a loan commitment. It does say, in general terms, that that based upon an initial conversation, you would qualify for a loan. As we engage in making an offer, it becomes an instrument which re-enforces the quality of it; and helps set the stage for serious negotiations.
If you are like most purchasers, you will want to borrow a large portion of the purchase price for your home by obtaining a loan. Prior to entering into a contract to purchase a home, you should contact a mortgage broker or lender to obtain pre-approval for financing. Next to finding a home, the loan application process will be the most time-consuming task in purchasing a home. By selecting your mortgage broker or lender, completing a loan application, and assembling and submitting the financial documentation required for the loan package prior to signing a contract, you will gain the following advantages:
- You will know how much you can borrow, so you will not waste time looking at properties you cannot afford.
- You will have an advantage over other purchasers when you make an offer, since the seller will know you are qualified to get a loan and can close quickly.
- You will save time on closing your loan, because you already have assembled the required documents.
There are many loan programs available for financing a home purchase. You should be familiar with the important differences between the various types of loans available to get the one that is best for you. The type of financing you choose will make a big difference in your ability to afford the home you wish to purchase as well as with the ultimate financing costs that you will assume.
Differences Between a Coop Loan and a Mortgage LoanA purchaser financing the purchase of a coop apartment will apply for a loan specific to coops. Cooperative financing is different from other types of housing loans because you do not get a mortgage in the traditional sense of the term. Since you will be buying shares of stock in a corporation that owns the building rather than the real estate itself, you will be pledging your stock in, and proprietary lease with, the corporation as collateral for the loan. In effect, you will be getting a loan to buy the shares and to obtain a proprietary lease to live in the designated coop unit. At closing, you will sign a promissory note (which evidences the debt) and a security agreement which pledges the shares and the proprietary lease for the apartment as collateral for the repayment of the loan and will give the lender the right to take back the apartment in a foreclosure action if you fail to repay the loan. Prior to closing, your lender’s attorney will file a UCC-1 Financing Statement in the county clerk’s or register’s office to place a lien on the coop shares that you will be purchasing.
A buyer financing the purchase of a condo or a house will obtain a mortgage loan. When you obtain a mortgage loan, the property you will be purchasing is pledged to the bank as collateral for the loan. At closing, you will execute a mortgage note that evidences the debt and contains a promise to repay the loan, a mortgage that pledges the condo or house as collateral for the repayment of the loan, and other loan documents that set forth the terms of the loan. After the closing, your title company will arrange to record the mortgage in the county clerk’s office in the county where the condo or house is located.
Types of LoansWhile there are many loan products available to a home purchaser, the best home mortgage loan is the one you can afford for as long as you plan to own your home. Affordability varies with the types of mortgage loans. In the rush to make an offer on a home, you might not think that you have time to spend sorting through the many options and loan products available. Taking the time to consider the different types of loans can pay great dividends. If you consider only the variables of interest rates and your monthly payment, you could pay thousands of dollars more than you should over the life of your loan. Examine the various types of loan products available for financing the purchase of a home. Also, be aware that many coop buildings have limitations on how much you can borrow for the purchase of the residence. Most coop buildings do not allow a loan in excess of 75 to 80 percent of the purchase price. There are no such restrictions on condos or private homes.
Generally, monthly home loan payments will consist of principal (the amount of the debt to be repaid), interest (the fee, based upon a percentage, charged by the lender for lending the money), and in the case of condos and houses, real estate taxes and homeowner’s insurance. The principal amount of the loan that will be repaid is reduced over time with each monthly payment of a portion of the principal.
Common Loan ProductsHistorically, fixed rate loans were the most common loan product. There are, however, some basic loan products, and many variations on each product as described below:
- Fixed Rate Loans. The interest rate is set before you close the loan and remains the same for the entire term of the loan. With each monthly payment, you repay a portion of the original loan amount (the principal) plus interest. With a 30 or 15 year fixed rate loan, the monthly payment will repay the original loan amount completely by the end of the loan term. Loans with a repayment schedule are called amortizing loans. The amount of interest plus the loan repayment is called the debt service payment.
- Adjustable Rate Loans. Also known as adjustable rate mortgages (ARMs), these loans differ from fixed rate loans because the interest rate and the monthly payments move up and down as market interest rates fluctuate. Most ARMs have an initial interest rate period during which the borrower’s interest rate does not change followed by a much longer period during which the rate changes at preset intervals. Interest rates charged during the initial periods generally are lower than those on comparable fixed rate mortgages. Most adjustable rate mortgages have fixed rates for the first three, five, seven, or 10 years, followed by rates that adjust annually thereafter. Borrowers will have some protection from exceptional changes in the interest rate because ARMs come with rate caps. These caps limit the amount by which ARM rates can adjust. The most common caps are period rate caps – which limit the amount by that an interest rate can rise in any given year – and lifetime caps – which limit how much the interest rates can rise over the life of the loan.
- Interest Only Loans. An interest only loan allows you to pay just the interest on the loan for a set period, often the first 5 or 10 years. You do not have to pay any principal during that time. When the interest only period is up, the interest rate is adjusted to the prevailing market rate, and the monthly payments will increase as you begin to pay the principal over the remaining term of the loan. You always have the option of making more than the minimum payment and having it applied toward the principal. You can use an interest only loan to free the cash that would otherwise go toward paying the principal and invest the cash where it can theoretically bring a better rate of return.
- Negative Amortization Loans. A loan that allows negative amortization means that the borrower is allowed to make a monthly mortgage payment that is less than the interest actually owed during that month. The result is that the outstanding balance of the loan is actually increased rather than decreased as with loans that amortize (reduce) principal. Editor's note: This form of loan has largely disappeared as the credit crisis has unfolded because of it's toxic effects; see this recent news article for more.
- Home Equity Line of Credit (HELOC). You may be able to obtain a second loan if you want to borrow more than eighty (80%) percent of the purchase price. A HELOC loan may be obtained with your primary lender or with a different lender. The interest rate on a HELOC loan generally changes monthly and is tied to the prime rate.
Financing TerminologyWhen you are deciding which loan product to choose, you should be familiar with the following loan terms:
- Amortization. The process of paying the principal and interest on a loan through regularly scheduled installments. The majority of each payment is applied toward interest owed initially. The later payments on the loan are increasingly applied toward the principal.
- Principal. The sum of money you borrow from the bank.
- Interest. Expressed as a percentage called the interest rate, it is the fee that the lender charges you to use the money you borrow.
- The Term. The period of time for which you borrow the money. Most loans are either 15 or 30 years.
- Rate Lock. An agreement with your lender whereby your lender agrees to give you a specific interest rate if you close your loan within a specified period of time. Rate lock periods generally run from 30 to 60 days and may be extended for an additional fee paid to the lender. Generally, the longer the term of the lock-in period, the higher the interest rate. It is important to remember that there frequently are delays in closings. This is particularly true when purchasing a coop apartment, since board approval is required before you can close. In addition, a seller has the right to postpone the closing date beyond the date in the contract if he or she is not able or ready to close. You should consult with your attorney before locking in your interest rate so that you do not prematurely lock in your rate.
- Escrow. A special account that a lender uses to hold a borrower’s monthly payments for monthly real estate taxes and insurance.
- Equity. A determination of the value of a property after existing liens are deducted.
- Points. A percent of the loan amount. One point equals one (1%) percent of the loan amount.
- Discount Points (also known as the Loan Origination Fee). A fee that you can pay to your lender to lower your interest rate. Generally, for each point you pay for a 30 year loan, your interest rate is reduced by 1/8th (0.125) of a percentage point. Lenders offer various rate and discount point combinations.
- Application and Processing Fees. Fees charged for evaluating, preparing, and submitting a loan application to a lender.
- Conforming Mortgage Loan. Any loan that is at or below the amount that Fannie Mae or Freddie Mac can purchase or securitize in the secondary loan market. Your mortgage broker or loan officer can tell you what the current loan limit is.
- Federal Funds Rate. The interest rate that banks charge each other on overnight loans made between them. These loans generally are made so that banks can cover their daily cash flow and reserve requirements. The rate is determined by the supply and demand of the funds.
- Fannie Mae and Freddie Mac. The nation’s two federally chartered and stockholder-owned mortgage finance companies. These banks do not provide loans on a retail basis. They instead purchase and/or securitize loans made by other banks. Since these banks are directed by their charters to serve moderate- and middle-income families, they have loan limits on the purchase or securitization of mortgages.
- Jumbo Mortgage Loan. A loan for an amount exceeding the Fannie Mae and Freddie Mac loan limit. A loan in excess of this limit is considered a jumbo loan and generally carries a higher interest rate.
- Loan to Value Ratio (LTV). The money borrowed relative to the value of the property. An LTV of eighty (80%) percent means that the loan amount equals eighty (80%) percent of the value of the property.
- FHA Loans. The federal government, through the Federal Housing Administration (FHA), helps low and moderate income families to become homeowners by providing an insurance program that encourages lenders to make loans to borrowers who might not be able to meet conventional underwriting requirements by insuring the lenders against loan defaults.
- Primary Residence. A home used as one’s primary residence will qualify for a lower interest rate than one used as second home.
- Prepayment Penalty. A loan which requires that the borrower pay a fee to the lender if the loan is paid off in full or in part before the term of the loan expires.
- Underwriting. The determination of the risk a lender would assume if a particular loan application is approved. Ability and willingness to abide by the mortgage loan terms as well as the value of the property involved are factors in the underwriting analysis.
- Appraisal. An appraisal is performed on behalf of a bank in the process of evaluating a borrower for a mortgage. The purpose of an appraisal is to determine if the price you are paying for the home is justified by recent sales of comparable properties. The property’s market value must meet the bank’s requirements.
About the author: Keith A. Schuman, Esq. is the founder of Schuman & Associates, LLC, a full service real estate firm that provides legal services to its clients, through all aspects of their transactions. Keith is a frequent contributor to comitini.com. Contact him at firstname.lastname@example.org or phone 212.490.0100.
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