Tag Archives: Borrower

What Is a Promissory Note?

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by Zoli Erdos

Realtor.com quoted me in What Is a Promissory Note? What You’re Really Promising, Revealed. It opens,

If you get a mortgage to buy a home, you will end up signing something called a promissory note. So what exactly is a promissory note?

In the most basic terms, it’s a legal document you sign containing a written “promise” to pay a lender, says Scott A. Marcus, a shareholder in Becker & Poliakoff’s Real Estate Practice Group, in Fort Lauderdale, FL.

Promissory notes are a standard part of all real estate financing contracts and include basic information such as:

  • The amount due
  • The terms of repayment (e.g., do the payments include principal and interest, or only interest)
  • The interest rate and whether it can change or is fixed
  • Whether there is a prepayment penalty
  • The loan maturity date
  • The names of the lender and borrower

Promissory notes are an important yet often misunderstood part of the loan process.

“The worst mistake someone signing a promissory note can make is to sign a note without reading and understanding all of its terms,” says Marcus.

So let’s clear up a few common misconceptions, shall we?

Promissory note vs. a mortgage: What’s the difference?

Many home buyers mistakenly think that the mortgage—another contract they sign—is their promise to pay back the loan.

Well, they’re wrong! The promissory note is your promise to do that, plain and simple. The mortgage, on the other hand, is a contract that kicks in more when things go wrong.

In a nutshell, a mortgage (also called a deed of trust) is a pledge you sign to put up your property as collateral in case you default on your loan, according to David Reiss, professor of law at Brooklyn Law School and editor of REFinBlog.com.

In other words, if you suddenly find yourself unable to repay your home loan, your lender will eventually confiscate your property and sell it as a foreclosure to help it recoup its losses from lending you all that money.

Enlarging The Credit Box

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The Hill published my column, It’s Time to Expand The Credit Box for American Homebuyers. it reads,

The dark, dark days of the mortgage market are far behind us. The early 2000s were marked by a set of practices that can only be described as abusive. Consumers saw teaser interest rates that morphed into unaffordable rates soon thereafter, high fees that were foisted upon borrowers at the closing table and loans packed with unnecessary and costly products like credit insurance.

After the financial crisis hit, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The law included provisions intended to protect both borrowers and lenders from the craziness of the previous decade, when no one was sufficiently focused on whether loans would be repaid or not.

The Consumer Financial Protection Bureau (CFPB) promulgated the rules that Dodd-Frank had called for, like the ability-to-repay and qualified mortgages rules. These rules achieved their desired effect as predatory mortgage loans all but disappeared from the market.

But there were consequences, and they were not wholly unexpected. Mortgage credit became tighter than necessary. People who could reliably make their mortgage payments were not able to get a mortgage in the first place. Perhaps their income was unreliable, but they had a good cushion of savings. Perhaps they had more debts than the rules thought advisable, but were otherwise frugal enough to handle a mortgage.

These people banged into the reasonable limitations of Dodd-Frank and could not get one of the plain vanilla mortgages that it promoted. But many of those borrowers found out that they could not go elsewhere because lenders avoided making mortgages that were not favored by Dodd-Frank’s rules.

Commentators were of two minds when these rules were promulgated. Some believed that an alternative market for mortgages, so-called non-qualified mortgages, would sprout up beside the plain vanilla market, for good or for ill. Others believed that lenders would avoid that alternative market like the plague, again for good or for ill. Now it looks like the second view is mostly correct and it is mostly for ill.

The Urban Institute Housing Finance Policy Center’s latest credit availability index shows that mortgage availability remains weak. The center concludes that even if underwriting loosened and current default risk doubled, it would remain manageable given past experience.

The CFPB can take steps to increase the credit box from its current size. The “functional credit box” refers to the universe of loans that are available to borrowers. The credit box can be broadened from today’s functional credit box if mortgage market players choose to thoughtfully loosen underwriting standards, or if other structural changes are made within the industry.

The CFPB in particular can take steps to encourage greater non-qualified mortgage lending without needing to amend the ability-to-repay and qualified mortgages rules. CFPB Director Richard Cordray stated earlier this year that “not a single case has been brought against a mortgage lender for making a non-[qualified mortgage] loan.”

But lenders have entered the non-qualified mortgage market very tentatively and apparently need more guidance about how the Dodd-Frank rules will be enforced. Moreover, some commentators have noted that the rules also contain ambiguities that make it difficult for lenders to chart a path to a vibrant non-qualified mortgage line of business. Lenders are being very risk-averse here, but that is pretty reasonable given that some violations of these rules can result in criminal penalties, including jail time.

The mortgage market of the early 2000s provided mortgage credit to too many people who could not make their monthly payments on the terms offered. The pendulum has now swung. Today’s market offers very few unsustainable mortgages, but it fails to provide credit to some who could afford them. That means that the credit box is not at its socially optimal size.

The CFPB should make it a priority to review the regulatory regime for non-qualified mortgages in order to ensure that the functional credit box is expanded to more closely approximate the universe of borrowers who can pay their mortgage payments month in, month out. That would be good for those individual borrowers kept out of the housing market. It would also be good for society as a whole, as the financial activity of those borrowers has a multiplier effect throughout the economy.

Promissory Note v. Mortgage

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photo by Thugvillage

 

Zing! quoted me in What’s the Difference Between a Promissory Note and a Mortgage? It opens,

Buying a home can sometimes feel like learning a new language. Preapprovals, appraisals and the fact that “concessions” don’t involve hot dogs at a baseball game can be more than a little bewildering for first-time homebuyers. If you’re in the market for a mortgage, the more you know, the more confident you’ll be with each transaction during the life of the loan. If you find yourself scratching your head over mortgage lingo, we’d like to make your contract a little clearer by explaining two items that are often confused for one another: a promissory note and a mortgage.

What’s a Promissory Note?

Essentially, a promissory note is an agreement that promises that the money borrowed from a lender will be paid back by the borrower. “It also includes how the loan is to be repaid, such as the monthly amount and the length of time for repayment,” explains David Bakke, a finance expert at MoneyCrashers.com.

Although the home loan process involves both a mortgage and a promissory note, a promissory note can be used singularly in a lending relationship between two individuals. In this case, a promissory note is simply a promise to pay back the amount of money that is borrowed in a set amount of time.

“Another way to think of it is that the promissory note is the IOU for the home loan,” says David Reiss, who teaches about residential real estate as a law professor at Brooklyn Law School in New York.

What Is a Mortgage?

The second part of the home loan involves a mortgage, also referred to as a deed of trust. While a promissory note provides the financial details of the loan’s repayment, such as the interest rate and method of payment, a mortgage specifies the procedure that will be followed if the borrower doesn’t repay the loan.

“The actual home loan (or mortgage) provides information as far as the lender being able to demand complete repayment if the loan goes into default, or that the property can be sold if the buyer fails to repay,” says Bakke.

In the case of a home loan, the promissory note is a private contract between the client and the lender, while the mortgage is filed in the regional government records office. “Once you have paid off your loan your lender will record a document that releases you from the liability of the deed of trust and the promissory note,” says Ross Kilburn, CEO of Ark Law Group, PLLC.

It’s a Package Deal

In the home loan process, a mortgage and a promissory note are not a question of one or the other, but rather, both play distinct roles in the relationship between the lender and borrower. “A home loan refers to a transaction where a borrower borrows money from the lender and in turn signs a promissory note that reflects the indebtedness as well as a mortgage that gives a security interest in the home in case the debt is not paid back,” explains Reiss.

Retired With A Mortgage

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photo by Katina Rogers

U.S. News & World Report quoted me in Rethinking a Mortgage While Retired. It opens,

It’s one of the cardinal rules of retirement planning: pay off the mortgage before quitting work. Giving up your income while still supporting a big debt can mean chewing away at your retirement savings way too fast, and can leave you in a tight spot if something goes wrong.

But paying off a mortgage years early is easier said than done, and the Center for Retirement Research at Boston College says way too many pre-retirees are too far behind schedule, largely because of borrowing before the housing bust and financial crisis.

On the other hand, some experts say carrying low-interest debt into retirement is not always such a bad thing, especially if it means leaving money in investments that perform well.

“In 2013, almost 40 percent of all households ages 55 and over had not paid off their mortgages, up from 32 percent in 2001,” the Center reports, citing a study using data from the Federal Reserve’s Survey of Consumer Finances in 2013. “These borrowers were also carrying a lot more housing debt by 2013.”

“I’ve been advising clients for over 20 years and on just an anecdotal level, I can tell you that more clients are retiring with mortgage balances than in years past,” says Margaret R. McDowell, founder of Arbor Wealth Management in Miramar Beach, Florida.

A.W. Pickel III, president of the Midwest division of AmCap Mortgage in Overland Park, Kansas, says many baby boomers traded up as their families grew, then took second mortgages to help fund college costs.

In the years before 2008, homeowners were encouraged to take out big loans when home values appeared to be soaring, the center says. They bought expensive homes or tapped home value through cash-out refinancing or home equity loans, it says.

When home prices collapsed, millions were left “underwater” – owing more than their homes were worth – and were unable to get out from under because they could not sell for enough to pay off their loan. McDowell believes many homeowners also concluded their home was not the rock-solid asset they’d thought, so they felt it unwise to pour more money into it by paying down the mortgage early.

So many just hung in there. By taking on too much debt, and monthly payments so large they could not afford extra payments to bring it down, they left themselves with too much debt too late in the game.

The center says “that 51.6 percent of working-age households were at risk of having a lower standard of living in retirement,” largely because of mortgage debt.

“In recent years, U.S. house prices have started to really improve, to the benefit of homeowners and retirees,” the center says. “But it’s difficult to predict whether the other factor that has reduced retirement preparedness – more older households with big housing debts – was a boom-time phenomenon or represents the new normal.”

But is the situation really as dire as it seems? David Reiss, a professor at Brooklyn Law School in New York City, thinks it may not be.

“According to the National Association of Realtors, the median sales price of an existing home increased from $197,100 in 2013 to $232,200 in October of 2016,” he says. “That is a roughly 15 percent price increase and about $40,000 of additional equity for the owner of the median home.”

Many homeowners who were underwater may not be any longer.

Also, he adds, it’s not necessary to be absolutely debt free at retirement so long as income is large enough to cover expenses and leave a cushion.

“Often, paying off a mortgage gets a retiree where he or she needs to be in terms of that balance, but it is not always necessary,” he says.

The key, he says, is to not be underwater. Once the remaining debt is smaller than the home value, the homeowner is better able to sell. One option is downsizing, selling the current home, then using cash from the sale or a new, smaller mortgage to buy a cheaper home. A less expensive home will also likely have lower property taxes and maintenance costs.

All About Mortgage Brokers

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photo by Day Donaldson

Bankrate.com quoted me in Mortgage Broker — Everything You Need To Know. It opens,

When you need a mortgage to buy or refinance a home, there are 3 main ways to go about applying — through a traditional brick-and-mortar bank, an online lender or a mortgage broker (either in-person or online).

Many people first think about shopping for a mortgage where they already have their checking and savings accounts, which is often a major bank or a local credit union. And applying online with a traditional bank or online-only lender has become more common.

But while borrowers are probably the least familiar with using a mortgage broker, it comes with many benefits.

Here’s everything you need to know about using a mortgage broker. 

Working with a mortgage broker

A mortgage broker connects a borrower with a lender. While that makes them middlemen, there are several reasons why you should consider working with a broker instead of going straight to a lender.

For starters, brokers can shop dozens of lenders to get you the best pricing, says Casey Fleming, author of “The Loan Guide: How to Get the Best Possible Mortgage” and mortgage advisor with C2 Financial Corp. in San Jose, California.

Fleming says the price he charges for certain lenders or banks is very often better than the price a consumer could get by going directly to the same lender.

“When the lender outsources the loan origination and sales function to a broker, they offer to pay us what they would otherwise pay to cover their internal operations for the same function,” Fleming says.

“If we are willing to work for less than that—and that is usually the case—then the consumer’s price through a broker ends up being less than if they went directly to the lender,” he explains.

Further, “A broker is legally required to disclose his compensation in writing — a banker is not,”says Joe Parsons, senior loan officer with PFS Funding in Dublin, California, and author of the “Mortgage Insider blog.”

Variety is another benefit of brokers. It can help you find the right lender.

“Some may specialize in particular property types that others avoid. Some may have more flexibility with credit scores or down payment amounts than others,” says David Reiss, a law professor who specializes in real estate and consumer financial services at Brooklyn Law School in New York and the editor of REFinBlog.com.

In addition, brokers offer one-stop shopping, saving borrowers time and headaches.

“If you are turned down by a bank, you’re done — you have to walk away and begin again,” Fleming says. But “If you are turned down by one lender through a broker, the broker can take your file to another lender,” he adds. The borrower doesn’t need to do any extra work.

A broker’s expertise and relationships can also simplify the process of getting a loan.

Brokers have access to private lenders who can meet with you and assess whether or not you have the collateral, says Mike Arman, a retired longtime mortgage broker in Oak Hill, Florida.

Private lenders, which include nonbank mortgage companies and individuals, can make loans to borrowers in unconventional situations that banks can’t or won’t because of Dodd-Frank regulations or internal policy.

You may get a better price on a loan from a broker as well.

Under the Consumer Financial Protection Bureau’s Loan Originator Compensation rule, brokers (but not bank lenders) must charge the same percentage on every deal, so they can’t raise their margin “just because” like a bank can, Fleming explains.

“The intent was to prevent originators from steering borrowers to high-cost loans in order to increase their commission,” Fleming notes.

You should also know that working with a broker won’t make your loan more expensive.

“The lender pays us, just like a cruise line pays a travel agent,” Fleming says.

Working with a traditional bank lender

Banks issue less than half of mortgages these days, according to the industry publication Inside Mortgage Finance. But working with a broker isn’t necessarily a slam dunk.

“A broker may claim that he offers more choices than a banker because he works with many lenders,” Parsons says. “In reality, most lenders offer pricing on their loans that is very similar.” Although, he notes, a broker may have available some niche lenders for unusual circumstances.

Reiss says that even if you’re working with a mortgage broker, it can be worthwhile to check out lenders on your own since no broker can work with every lender — there are simply too many. He suggests starting with lenders you already have a relationship with, but also looking at ads and reaching out directly to big banks, small banks and credit unions in your community.

It’s important to know your range of options, he notes.

For the same reason, you might want to shop around with a few different brokers.

Housing Finance Reform, Going Forward

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photo by Michael Vadon

President-Elect Trump

Two high-level officials in the Treasury Department recently posted Housing Finance Reform: Access and Affordability Going Forward. It highlighted principles that should guide housing finance reform going forward. It opened,

Access to affordable housing serves as a cornerstone of economic security for millions of Americans. The purchase of a home is the largest and most significant financial transaction in the lives of many households. Access to credit and affordable rental housing defines when young adults start their own households and gives growing families options in choosing the quality and location of their homes. Homeownership can be an opportunity to build wealth, placing a college education within reach and helping older Americans attain a secure retirement. Whether they are aware of it or not, some of the most momentous decisions American families make are shaped by how the housing finance system serves them.

Financial reform has sought to reorient financial institutions to their core mission of supporting the real economy. The great unfinished business of financial reform is refocusing the housing finance system toward better meeting the needs of American families. How policymakers address this challenge will be the critical test for any model for housing finance reform. The most fundamental question any future system must answer is this: Are we providing more American households with greater and more sustainable access to affordable homes to rent or own? It is through this lens that we will assess the performance of the current marketplace and evaluate a set of policy considerations for addressing access and affordability in a future system. (1-2)

These principles of access and affordability have guided federal housing finance policy for quite some time, particularly in Democratic administrations. They now appear to fallen by the wayside as Republicans control both the Executive and Legislative branches.

President-Elect Trump has not yet outlined his thinking on housing finance reform. And the Republican Party Platform is somewhat vague on the topic as well. But it does give some guidance as to where we are headed:

We must scale back the federal role in the housing market, promote responsibility on the part of borrowers and lenders, and avoid future taxpayer bailouts. Reforms should provide clear and prudent underwriting standards and guidelines on predatory lending and acceptable lending practices. Compliance with regulatory standards should constitute a legal safe harbor to guard against opportunistic litigation by trial lawyers.

We call for a comprehensive review of federal regulations, especially those dealing with the environment, that make it harder and more costly for Americans to rent, buy, or sell homes.

For nine years, Fannie Mae and Freddie Mac have been in conservatorship and the current Administration and Democrats have prevented any effort to reform them. Their corrupt business model lets shareholders and executives reap huge profits while the taxpayers cover all loses. The utility of both agencies should be reconsidered as a Republican administration clears away the jumble of subsidies and controls that complicate and distort home-buying.

The Federal Housing Administration, which provides taxpayer-backed guarantees in the mortgage market, should no longer support high-income individuals, and the public should not be financially exposed by risks taken by FHA officials. We will end the government mandates that required Fannie Mae, Freddie Mac, and federally-insured banks to satisfy lending quotas to specific groups. Discrimination should have no place in the mortgage industry.

Turning those broad statements into policies, we are likely to see some or all of the following on the agenda for housing finance reform:

  • a phasing out of Fannie Mae and Freddie Mac, perhaps via some version of Hensarling’s PATH Act;
  • a significant change to Dodd-Frank’s regulation of mortgage origination as well as a full frontal assault on the Consumer Financial Protection Bureau;
  • a dramatic reduction in the FHA’s footprint in the mortgage market; and
  • a rescinding of Obama’s Affirmatively Furthering Fair Housing Executive Order.

Some are already arguing that Trump and Congress will take a more pragmatic approach to reforming the housing finance system than what is outlined in the Republican platform. I think it is more honest to say that we just don’t know yet what the new normal is going to be.

Can Seniors Get Mortgages? Should They?

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photo by Bill Branson

TheStreet.com quoted me in Can Seniors Get Home Mortgages? Should They? It reads, in part,

Senior citizens can and are getting approved for mortgages, and we are not talking reverse mortgages or home equity lines of credit, but – in many cases – 30-year fixed loans. Even when the borrower might be 85 and the actuarial probability of making it to the end of the loan term is nil.

The federal government is blunt: age cannot be used to discriminate against applicants for home loans. Capacity to repay is a factor – for seniors and every other borrower – but a lender cannot turn down an applicant just because he is 65…or 75…or 85. And loans are getting made.

Which raises the other question: is it wise for the borrower? Bankers can take care of themselves, but seniors need to ask: should I be borrowing a lot of money on a house at my age?

In Vancouver, Wash., Dick Kuiper – who said he is “approaching 70,” as is his wife – “just purchased a new home last year and got a 30 year mortgage at just under 3%, and we both believe this was a brilliant move.”

“We first made sure we made a large enough down payment so we would always have positive equity in the home,” Kuiper elaborates. “With that calculated, we looked at the alternatives, either pay in cash – which would naturally come out of our savings – or take out a mortgage. We looked at what we could get by putting the same amount of money into a retirement annuity with a downside guarantee. That annuity pays a minimum of 5% for life and currently is paying in the 8% to 9% range. Do the math. We’d be crazy to pay cash for the house.”

Kuiper’s right. For his wife and him, it made no sense to pay cash for a house – not when mortgage rates are breathtakingly low.

Case closed? Not at all.

Ash Toumayants, founder of financial advisors Strong Tower Associates in State College, Pa., said that in his experience few seniors ever want another mortgage in retirement after they settled up on their first one. “Most are excited when they pay it off and don’t want another one,” Toumayants says.

Another fact: to get a mortgage, a senior has to demonstrate to a lender a capacity to repay. Age cannot be used against a senior, but lack of cashflow can. And many seniors just have sizable trouble qualifying for a mortgage. “The trick is whether they have enough income to qualify or not,” said Casey Fleming, a mortgage expert in Northern California who said that he right now is working on a loan for an 85-year-old client.

Brian Koss, executive vice president of Mortgage Network, an independent mortgage lender in the eastern U.S., elaborated: “For seniors thinking about getting a mortgage, it’s all about income flow. If you have a consistent source of income, and a mortgage payment that fits that income, it makes sense. Something else to consider: if you have income, you have taxes and a need for a tax deduction. With a mortgage, you can write off the interest.”

*     *     *

But then there is an ugly issue to confront. Is the senior arriving at this purchase decision on his own steam? Brooklyn Law professor David Reiss explained why that needs to be asked. “Seniors should discuss big financial moves with someone whose judgment they trust (and who does not stand to benefit from the decision). Elder financial abuse is rampant.”

Reiss added: “What has changed in their financial profile that is leading them to do this? Is someone – a relative, a new friend – egging them on or leading them through the process?” Reiss is right in the caution, and that’s a concern that has to be satisfied.