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Real Estate Finance


1. History and Background 1

Key Words and Phrases 1 Introduction 2
Landownership 3
Background of Financing Financing Real Property Loans 4
The Mortgage Loan Market 5
Financial Market Instruments 5
A Look at the Future 8
Questions for Discussion 12
Multiple Choice Questions for Review 12
Answer Key for Multiple Choice Questions 13
Additional Online Resources 13

2. Money and Interest Rates 14

Key Words and Phrases 14
Introduction 15
Federal Reserve Bank System 15
The United States Treasury 22
Interest Rates 23
Usury 29
Questions for Discussion 29
Multiple Choice Questions for Review 29
Answer Key for Multiple Choice Questions 30
Additional Online Resources 30

3. Mortgage Money: Regulated Lenders 31

Key Words and Phrases 31
Introduction 32
The Mortgage Credit Market 32
The Mortgage Money Market 33
The Primary Market 34
Reserve Requirements for Depository Institutions 43
Deposit Insurance 43
Community Reinvestment Act (CRA) 44
Additional Federal Regulation of Home Mortgage Lending 45 Life Insurance Companies 47
Questions for Discussion 48
Multiple Choice Questions for Review 49
Answer Key for Multiple Choice Questions 50
Additional Online Resources 50

4. Other Primary Market Lenders 51

Key Words and Phrases 51
Introduction 52
Mortgage Companies 52
Automated Loan Underwriting 63
Government Loan Programs 64
United States Department of Agriculture Rural Development 65
Other Primary Market Lenders 66
Miscellaneous Other Sources 70
Questions for Discussion 71
Multiple Choice Questions for Review 71
Answer Key for Multiple Choice Questions 72
Additional Online Resources 72

5. Mortgage Money: The Secondary Market 73

Key Words and Phrases 73
Introduction 74
Expansion of the Secondary Market 74
Selling Mortgage Loans 75
Points 78
Loan Purchasers 78
Federal Underwriting of Mortgage Pools 82
Mortgage Partnership Finance Program (MPF) 87
Loan Pools 88
Tax-Exempt Bonds 90
Mortgage-Backed Securities (MBS) 91
Real Estate Mortgage Investment Conduits (REMIC) 94
Questions for Discussion 95
Multiple Choice Questions for Review 95
Answer Key for Multiple Choice Questions 96
Additional Online Resources 96

6. The Mortgage Documents 97

Key Words and Phrases 97
Introduction 98
History and Development 98
State Laws Control Property Rights 98
Conforming Loans 102
Mortgage Variations 106
Mortgage Procedures 116
Standardizing Loan Documentation 118
Questions for Discussion 120
Multiple Choice Questions for Review 120
Answer Key for Multiple Choice Questions 121
Additional Online Resources 121

7. Mortgage Repayment Plans 122

Key Words and Phrases 122
Introduction 123
Fixed-Interest, Constant-Level Plan 123
Adjustable Rate Mortgage (ARM) 124
Graduated Payment Mortgage (GPM) 131
Buydown Mortgage 132
Pledged-Account Mortgage 133
Balloon Payment Note 133
Straight Note (More Popularly Advertised as an Interest-Only Mortgage) 134
The Piggyback Loan 135
Mortgages that Can Reduce Total Interest Cost 136
Home Equity Revolving Loans 138
Other Alternative Plans 139
Reverse Annuity Mortgage (RAM) 140
Questions for Discussion 142
Multiple Choice Questions for Review 143
Answer Key for Multiple Choice Questions 143
Additional Online Resources 144

8. Federal Government Underwriting Programs 145

Key Words and Phrases 145
Introduction 146
Federal Housing Administration (HUD/FHA) 147
FHA Mortgage Insurance Premiums 150
Assumption of an FHA Loan 152
Investor Mortgagors Eliminated 154
Loan Default and Foreclosure 155
Interest Rate 156
Secondary Financing with HUD/FHA-Insured Commitments 158
HUD/FHA Program Details 158
HUD/FHA Qualification Procedures 164
Analyzing the Loan Application 165
Department of Veterans Affairs (VA) 167
Questions for Discussion 179
Multiple Choice Questions for Review 179
Answer Key for Multiple Choice Questions 180
Additional Online Resources 180

9. Borrower Qualification 181

Key Words and Phrases 181
Introduction 182
Equal Credit Opportunity Act 183
The Loan Application 184
Financial Evaluation of the Borrower 184
Qualifying the Applicant 193
Recent Additional Credit Score Requirements for HUD/FHA 196
VA Borrower Qualification 197
Commercial Loans 207
Private Mortgage Insurance 209
Questions for Discussion 212
Multiple Choice Questions for Review 213
Answer Key for Multiple Choice Questions 214
Additional Online Resources 214

10. Property Analysis 215

Key Words and Phrases 215
Introduction 216
Property Appraisal 216
Types of Appraisals 222
Three Approaches to Property Value 224
Property Characteristics 230
Condominiums 234
Cooperative Apartments 236
Manufactured Housing/Mobile Homes 236
Surveys 237
Legal Descriptions 238
Questions for Discussion 240
Multiple Choice Questions for Review 240
Answer Key for Multiple Choice Questions 241
Additional Online Resources 241

11. Commercial Loans: Construction and Land Loans 242

Key Words and Phrases 242
Introduction 243
Information Sources 243
The Loan Application 244
Preparation of Financial Statements 249
Property Evaluation 249
Land Purchase Loans 251
Land Development Loans 252
Construction Loans 254
Questions for Discussion 258
Multiple Choice Questions for Review 258
Answer Key for Multiple Choice Questions 259
Additional Online Resources 259

12. Commercial Building and Farm Loans 260

Key Words and Phrases 260
Introduction 261
Special-Purpose Buildings 261
Apartment Buildings 262
Retail Store Buildings 266
Shopping Centers 267
Office Buildings 270
Warehouse Buildings 272
Farm and Ranch Loans 274
Questions for Discussion 277
Multiple Choice Questions for Review 277
Answer Key for Multiple Choice Questions 278
Additional Online Resources 278

13. Other Financing Practices 279

Key Words and Phrases 279
Introduction 280
Home Builder Commitments 280
Loan-to-Value Ratio (LTV) 281
Dollar Amount of Loan 282
Land Leases 283
Financing Development on Leased Land 284
Sale of Equity Interests 286
SEC Regulations for Real Estate Transactions 287
Supplier Financing 288
Seller-Financed Home Mortgages 289
Refinancing 289
Title Protection 291
Foreclosure 293
Deficiency Judgments 295
Obligations Involved with Default Insurance: Indemnity 296
Questions for Discussion 297
Multiple Choice Questions for Review 297
Answer Key for Multiple Choice Questions 298
Additional Online Resources 299

14. Technology Advances in Mortgage Lending 300

Key Words and Phrases 300
Introduction 301
Computerized Loan Origination (CLO) 301
Loan Origination Systems 303
Automated Underwriting Systems 304
Credit Scoring 310
Subprime Loans 310
Mortgages on the Internet 312
Online Real Estate Service 313
Using Computerized Information in the Future 315
Questions for Discussion 316
Multiple Choice Questions for Review 316
Answer Key for Multiple Choice Questions 317
Additional Online Resources 317

15, Environmental Issues 319

Key Words and Phrases 319
Introduction 320
Environmental Assessments for Home Loans 320
Environmental Assessments for Commercial Loans 321
Environmental Requirements of the Secondary Market 321
Principal Environmental Problems 322
Toxic Waste Sites 323
Indoor Air Pollution 332
Lead Poisoning 334
Wetlands Protection 336
Endangered Species 338
Underground Storage Tanks 340
Electromagnetic Forces 341
Conclusions 343
Questions for Discussion 344
Multiple Choice Questions for Review 344
Answer Key for Multiple Choice Questions 345
Additional Online Resources 345

16. Settlement Procedures 346

Key Words and Phrases 346
Introduction 347
Preliminary Information 348
RESPA Requirements 349
Truth-In-Lending Act 357
Settlement Practices and Costs 359
Final Closing Instructions 366
Disbursement of Funds 372
Questions for Discussion 373
Multiple Choice Questions for Review 373
Answer Key for Multiple Choice Questions 374
Additional Online Resources 374



Real estate finance comprises three-fourths of total mortgage lending. Over the last ten years, residential real estate mortgage debt has risen at an astounding 9.875 percent per year—from $5.7 trillion in 1999 to a high water mark of $14.6 trillion at the end of 2008, the end of the first year of the “Great Recession.”

According to the house price index provided by the Federal Housing and Finance Agency, between 1999 and 2009 nominal house prices rose by 61 percent, a 4.875 percent compounded rate of increase. This fact suggests that the average household was drawing out equity at a compounded rate of 5 percent per year. Therefore, the real underlying problem with the mortgage crisis may have been an unsustainable real estate finance bubble.

During the past 15 years, the decline of interest rates to historically low levels, the development and acceptance of the originate-to-distribute model of residential mortgage loan production, and the availability of a seemly inexhaustible pool of funding from the sale of mortgage-backed securities combined to cause a corresponding spike in residential housing prices.

This rise in home prices opened the door to many new primary market lenders and ever more aggressive types of mortgage loan product features, which in turn led to lower underwriting standards. Such lowered standards allowed borrowers with limited capital or lower-than-normal credit standing to enter the housing market with increasing ease.

The changes that the past few years have wrought are driving changes to real estate financing. Government and the market are contributing to the creation of a new model of residential mortgage financing, one that will most likely include more risk sharing by loan originators over the life of loans made.

Real estate professionals of all kinds need a sound understanding of the specialized financing procedures used by lenders today, as well as a sense of the changes that are likely occur in future lending. The real estate market has a cyclical nature; it will flourish at times and then languish for a while. Such ups and downs are part of the normal workings of the free market system.

There is no central government planning authority empowered to set limits on the number of housing units that can be built in any given market area. However, state and federal governments and the policies of various departments and agencies can influence naturally evolving market trends.

The control of market demand is evident in what the United States has experienced between 2007 and the present based on the actions of the Federal Reserve Bank and U.S. Treasury Department taken to mitigate the tightening of credit markets for residential mortgage finance due to the recent financial crisis.

The ninth edition of this text on real estate finance retains its primary emphasis on residential financing because residential financing is more clearly structured by a set of uniform practices than is commercial real estate finance. The text has been completely updated in response to the important changes of the past several years.

The general format of the book has been retained; however, each chapter now begins with “Learning Objectives” designed to help students focus on the chapter’s key concepts. Moreover, a series of multiple-choice questions concludes each chapter to assist in reinforcing important concepts, and each chapter includes a listing of useful web links to additional resources to help students keep current or find additional materials.

Throughout the text students will find numerous new, updated, and enhanced topics, tables, and illustrations. Each chapter also includes a new boxed feature entitled “Where Are We Now.” Overall, this new edition presents the current information required by lend- ers, real estate agents, appraisers, investors, and regulators.

Additional changes to the ninth edition include the following:

Chapter 1—History and Background

Includes a revised section on the earliest history of taking security interests in real estate, as well as discussions of the effects of the recent financial crisis on short- term funding of mortgage loans; the importance of the Commercial Paper Funding Facility (CPFF), which provides a liquidity backstop to U.S. issuers of commercial paper as part of the intervention by the Federal Reserve Bank; events leading up to Fannie Mae and Freddie Mac’s being placed into government conservatorship in 2008; changes wrought by the Housing and Economic Recovery Act of 2008; the significance of the Mortgage Crisis; the importance of the massive backstop the Federal Reserve Bank has provided as the purchaser of last resort for the 18-month period after the conservatorship to allow a large majority of the secondary market to function, thus allowing mortgage lending to continue without disruption; and the significance of mortgage conduits.

Chapter 2—Money and Interest Rates

Includes discussions of how the money supply is reported and monitored by the Federal Reserve, including the discontinuation of M3 monetary aggregate in 2006; the concept of Money Zero Maturity; the monetary easing of bank reserve requirements in the late 1990s and its relationship to excess monetary expansion, which exacerbated the recent financial crisis; the Federal Reserve Bank’s expansion of its use of the discount window in response to the recent financial crisis; how and why several special emergency credit facilities were created in 2008 and 2009 and how the Dodd-Frank Act has curtailed their ability to do so without prior consultation with the Treasury Department; and changes to the Government Sponsored Enterprises’ commitment technology that have occurred since the publication of the eighth edition, including current information on Fannie Mae’s eCommittingTM, developed to allow approved conventional mortgage lenders more time to focus on growing their business, and eCommitONETM, an easy-to-use Web-based application that provides automated pricing information and Best Efforts committing pro- cesses. In addition, a new figure explains the organization of the Federal Reserve System.

Chapter 3—Mortgage Money: Regulated Lenders

Includes discussions of changes in the make-up of the primary and secondary mar- ket residential and commercial loan originators and securitization firms; the effects of the Emergency Economic Stabilization Act of 2008 on FDIC deposit insurance; the current lack of regulatory action leading to major changes in the way commercial banks can use asset-based lending for commercial real estate mortgages; how regulated lenders are graded under the Community Reinvestment Act; and the effects of the Higher Education Opportunity Act passed in 2008 on financial institutions.

Chapter 4—Other Primary Market Lenders

Includes discussions of how the market share leaders in residential mortgage loan production shifted from mortgage brokers to commercial banks; the qualifications of a mortgage lender; the events leading up to and the rationale behind the pas- sage of the Secure and Fair Enforcement for Mortgage Licensing Act of 2008; the establishment of the National Mortgage Licensing System; the major requirements to obtain a mortgage broker’s license under the new National Mortgage Licensing System; the Fraud Enforcement and Recovery Act of 2009 (FERA), which was intended to expand the federal government’s capacity to prosecute mortgage fraud, securities and commodities fraud, and other types of fraud related to federal assistance and relief programs such as the Troubled Assets Relief Program (TARP); yield spread premiums as used in mortgage lending, including a view of the recent changes to the Real Estate Settlements Procedures Act that occurred with the pas- sage of the Mortgage Disclosure Improvement Act of 2008, or “MDIA”; MDIA requirements that any yield spread premium be fully disclosed on the newly revised Good Faith Estimate; the dramatic changes in farm and farm-related lending for real estate; new types of real estate investment trusts that invest only in mortgage- backed securities; a Public-Private Investment Program (PPIP) that includes the legacy loans and legacy securities that are clogging the balance sheets of financial firms by using $75 to $100 billion in TARP capital and capital from private investors; and the universal adoption by states of down payment assistance pro- grams for low- to moderate-income first-time homebuyers that has occurred over the past ten years. This revised edition also contains a discussion of state housing agencies.


Chapter 5—Mortgage Money: The Secondary Market

Includes an explanation of the evolution of the subprime residential mortgage, including its demise as a popular mortgage product and its current lack of acceptance in the secondary market, as well as an introduction to the reasons for the develop- ment and use of Collateralized Debt Obligation (CDO).


Chapter 6—The Mortgage Documents

Includes discussions of state title laws and the differences between a title theory state and a lien theory state; the way in which the recent financial crisis has made
a borrower’s equity right of redemption something every real estate professional should understand; the changes to the National Flood Insurance Program and the fact of the program’s possible elimination due to funding issues; short sales and their tax consequences to the borrower; the lingering effects of the financial crisis leading to Congress passing Federal Bailout Legislation H.R. 1424 on October 3, 2008; and the Government-Sponsored Enterprises’ determination of the maximum conforming loan limits for conventional loans and how recent legislation has al- lowed some high-cost areas higher maximums to accommodate the market realities in those areas. This new edition also includes an updated section on federal tax claims and coverage of the ways in which state laws influence property rights.


Chapter 7—Mortgage Repayment Plans

Includes discussions of the rise in popularity of alternative mortgage payment plans, some of which are no longer available due to misuse or poor application
by mortgage loan originators; buydowns and how they are used, contrasting the differences and uses of a temporary versus a permanent buydown in residential mortgage lending; piggyback mortgages, including why they were developed and how they are used; how the new Mortgage Disclosure Improvement Act of 2008 changes aspects of home equity closed-end mortgage lending disclosures and advertising; the need to understand the varying tax aspects of new legislation, such as the impact of the Health Care and Education Reconciliation Act of 2010 on shared equity repayment programs; and the impact of various pieces of legislation that affect mortgage repayment plans, including changes such as those introduced by the Housing and Economic Recovery Act of 2008 that have reduced the lower closing cost benefits of reverse mortgage payment plans for seniors.


Chapter 8—Federal Government Underwriting Programs

Includes discussions of new legislation and its impacts on residential mortgage finance; the Economic Stimulus Act of 2008; the American Recovery and Reinvest- ment Act of 2009; the evolving hardening of standards for condominium loans for both conventional and FHA mortgage loans; the changes in FHA lending requirements and restrictions due to the Coastal Barrier Resources Act that took effect in 2011; the evolving nature of FHA upfront mortgage insurance due to Public Law 111-229, passed in 2010, which gave the Secretary of the Department of Housing and Urban Development great flexibility to change and specifically to increase mortgage insurance premiums; the extensive changes in FHA programs that have occurred since the eighth edition; an explanation of the changes in spousal benefits of Veterans Administration loan programs; and the expansion of the Homeowner’s Assistance Program benefits for private home sale losses.


Chapter 9—Borrower Qualification

Includes discussions of the Fair and Accurate Credit Transactions Act and the Privacy Act; current affordable housing options such as the Home Affordable Modification ProgramSM Fannie Mae program and others aimed at helping troubled borrowers with bad mortgage products recover; and the Housing Finance Agency Innovation Fund for the Hardest Hit Housing Markets, established by the U.S. Treasury Department in early 2010 to provide billions in targeted-aid funding to states hit hardest by the economic crisis. This chapter also covers the new “Making Home Affordable” programs.


Chapter 10—Property Analysis

Includes discussions of the Appraisal Foundation and its role in writing USPAP; the college degree requirement and the new examination and work experience requirements for new appraisal applicants, effective January 2010; the changes to the FHA appraisal requirement and prohibited practices with FHA Mortgagee Letter 2009–28, practices in which lenders, brokers, and other originators are prohibited from engaging; and the necessity of appraisers’ compliance with the Department
of Housing and Urban Developments Uniform Appraisal Dataset by December 31, 2011. This chapter also includes an updated list of professional appraisal groups that grant specialized professional designations—groups that have changed drastically as organizations have merged, become dormant, or have not retained status as a sponsor of the Appraisal Foundation.

New appraisal topics discuss Standards for Appraisers for FHA Mortgages and Appraiser Selection in FHA Connection.


Chapter 11—Commercial Loans: Construction and Land Loans

Includes discussions of the term “net operating income” from a property company P & L standpoint; how net operating income is used in audited financial statements; and how little regulatory oversight of commercial lending has been altered in spite of the recent financial crisis.


Chapter 12—Commercial Building and Farm Loans

Includes discussions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010; the effect of the extension of the Bush tax cuts, especially helpful to commercial real estate through 2012; Religious Facility Financing; and the consolidation of commercial mortgage brokers.


Chapter 13—Other Financing Practices

Includes discussions of the tax effects of the Emergency Economic Stabilization Act of 2008, including the extension of the debt relief provisions until 2012; the failure of the Federal Reserve Bank to act on information about emerging problems with subprime lending, which may have made the financial crisis more severe; and how the refinance market has been affected by the financial crisis.


Chapter 14—Technology Advances in Mortgage Lending

Includes discussions of the 2005 Bankruptcy Abuse Prevention and Consumer Protection Act and how it affects real estate finance; Freddie Mac’s Automated Valuation Model, called Home Value Explorer (HVE®), a tool that simplifies the mort- gage process by streamlining the collateral valuation cycle; Fannie Mae’s Desktop Underwriter; mortgages on the Internet and online real estate services; and the new Fannie Mae technology, for example Fannie Mae’s EarlyCheckTM service, which assists lenders in identifying and correcting potential eligibility and/or data issues early in the loan-application process.


Chapter 15—Environmental Issues

Includes discussions of the new E-1527-05 Standard for Environmental Site Assessments created by ASTM International (ASTM), originally known as the American Society for Testing and Materials; various key 2007 and 2009 Supreme Court decisions that will limit the Environmental Protection Agency (EPA) in holding companies accountable for the actions of third-party disposal companies; the Brownfields Program’s ability to leverage money for assessment, cleanup, and revitalization of brownfields, based on data from grantee reporting and the Pro- gram’s ACRES database; and the EPA’s s development of new guidance in response to the American Recovery and Reinvestment Act of 2009, making underground storage tanks the new “asbestos-type problem” of the decade. This chapter also covers a new topic, leadership in energy and environmental design.


Chapter 16—Settlement Procedures

Includes discussions of the new Good Faith Estimate and how it is used; other effects of the Mortgage Disclosure Improvement Act of 2008; changes to designated service provider rules for Fannie Mae, Freddie Mac, and FHA; the new disclosures required by the Helping Save Their Homes Act of 2009; the changes in settlement procedures caused by changes to the Real Estate Settlement Procedures Act in 2008 and 2010; and paperless closings.

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