INTRODUCTON
“One good real estate investment is worth a lifetime of labor.”
Throughout most of the country, substantial appreciation
has occurred with properties owned for 20-30 years or more. For most of us, the
value of our home or income property is critical to our financial security.
Clients over 55 are preparing to sell, retire, and/or relocate. Most of them
are realizing that their property’s equity is needed to maintain their current
lifestyle. Experience and training over the years should lead us to become an
expert in learning to save
every dollar possible for our clients.
In other words, it’s
not what you sell it for but what you get to KEEP that counts. Experience has proven that proper planning for the
eventual sale of your personal residence or investment property, with competent
professionals, is absolutely critical. Why? Because you and your family’s short
and long term financial security is at risk. In all too many instances, I have
witnessed people being trapped into making bad, irreversible real estate and
investment decisions. Without the professional input of an experienced Seniors
Real Estate Specialist®, a thoroughly prepared plan, and a top financial team,
many seniors and their families have lived to regret those snap decisions.
The purpose of this report is to trigger your thought and
planning processes. The real estate
problems and issues facing us, as seniors, are very different from other
property owners. A properly planned real estate strategy can help provide you
and your family with a comfortable income for the rest of your life. Detailed
discussions with a Seniors Real Estate Specialist®,
CPA, and Attorney are critical to your
success in any real estate transaction. I must urge you to seek the advice of
all of these professionals before making any major decisions about your
property.
SENIORS’ 15 MOST FREQUENTLY ASKED QUESTIONS/CONCERNS
Certain questions have come up repeatedly over the course
of numerous planning sessions with prospective senior sellers. The following
list summarizes the fifteen most commonly asked questions or concerns voiced
over the years. These clients have owned both homes and income property. In
some instances, they have lived in one of the income units. In those cases,
they were able to treat the unit as their home for real estate tax purposes.
Please remember that adding a “Seniors Specialist” REALTOR® along
with a CPA, Attorney, and Financial Planner to your support team can greatly
relieve your stress. We have used the “Question and Answer” format to simplify
the explanation of these considerations step by step.
1. I’ve already planned my retirement, so all I need to do now is
sell my property. Right?
Retirement planning is very different from the planning
required in selling your property. Many people have made economic plans based
on retiring at 60 or 65. We plan to live in our home until we either sell our
property or pass on. But sometimes circumstances change, and our property must
be sold in a relatively short period. Having a pre-planned financial strategy
for the sale of your property can make all the difference in the tax
ramifications you will face and the peace of mind you deserve.
It’s important to analyze all of the important factors
discussed in this report to ensure that you are properly prepared. Even though
you may not be planning to sell now, making these preparations will allow you
and your family to rest comfortably. Clients who may have to sell need to know
exactly what to do to gain the best possible economic outcome. Also, if
something happens and you’re unable to perform in the way you want, your
property’s equity can still provide for your security.
2. I’m going to have to pay taxes someday, so why don’t I just get
it over with now?
A certain percentage of clients feel like “Eventually we’ll
have to pay the piper, so why not do it now?” However, because today’s senior
can very easily live to 95 or older, seniors will probably need every dollar of
their equity. The money that you would pay on Federal and perhaps your State
government* (which is generally at 20% to 30% of the profit/gain that is made
on the sale) is money that you need to keep and use to earn interest for as
long as you can. Why? Because most of us probably will never be able to earn
this amount of money again. Recent studies have shown that we Americans live
longer and enjoy a more active life. We also have a greater need for cash flow
to maintain our lifestyle in the last quarter of our life. Proper planning and
tax considerations in the sale of your property are critical even though your
retirement situation may already be established. Later on we’ll look at a
couple of examples of how improper tax planning, or lack of planning, can
create horrendous tax consequences.
*With the 1997 Federal tax changes, it is
very important that you talk with your CPA, Tax Attorney, and REALTOR® to determine your current State capital gains tax requirements. Most clients realize a substantial appreciation (capital
gains) on their property and, as responsible citizens, believe that they should
pay their fair share of any tax responsibility. The question is when do you pay
it? Most of us need the cash flow from the taxable gains and are willing to let
our estates worry about paying the taxes. In most instances, this is the
approach to take. With proper planning, our cash flow is stable, and we save on
estate taxes as well.
3. If you specialize in tax-deferred sales, what do you suggest?
This is a question asked over and over again. The first
step in properly answering this question is to analyze, in detail, the
acquisition of the property that you’re considering selling:
♦ When did you acquire it?
♦ How did you acquire it?
♦ What are the costs incurred to improve it?
♦ Do you have written records of those expenditures?
♦ Is there current financing on it?
♦ Do you have it in a trust with a will?
♦ What’s the total value of your estate?
The 1997 Tax Reform Act makes a combination of several tax
benefit programs available. All property owners are now allowed to take the
$250,000 (single) or $500,000 (married couples) exemption from the sale of
their personal residence tax-free. You must
have lived there two of the last five years to qualify. This means that at the
time of sale any appreciation or profits up to these amounts are yours to keep,
invest, or spend for your future and NO taxes are due. If the gain
on your property is under the $250,000/$500,000 limits and you have other secure
places to invest your equity, then the most prudent plan may be to take the
tax-free cash proceeds and reinvest them.
4. We’ve owned a mountain resort property for years and want to
sell it, but the capital gains taxes are huge. What can you suggest?
There is a solution for your dilemma. The revised tax law
will allow you to move into your mountain home and claim it as your primary
residence for the next two years. Then you can sell it, and take either
$250,000 or $500,000 (depending on whether you’re single or married) from the
sale tax-free. You must actually live there, get your mail there, and
prove in an audit (if required) that this is your primary residence. If you own
an income property, for example, you can move into the largest unit in the
building for two years and use it as your primary residence. A substantial part
of the potential taxable profit could be turned into your home deduction and
treated as a tax-free sale. While this may be a short term inconvenience, it
could legally save you thousands. It is important to consult with your Seniors
Real Estate Specialist®, CPA, and the rest of your financial team. Perhaps a combination of tax-free
profits and the installment sale could save you thousands of dollars and give
you management free income for the rest of your life. If you plan to just place
the money from the sale in the bank as a CD (certificate of deposit) or if you
are concerned about keeping others from taking or using these funds you should
consider the installment sale. You may obtain a substantially better interest
rate return by carrying the First Mortgage/Trust Deed on your property. Ask
these questions of your local Seniors Real Estate Specialist®, CPA, and your
other advisors.
The installment sale is certainly one of the more
beneficial provisions that the government has created with the IRS code. It
allows deferring the payment of federal taxes in any sale on the equity that is
taken back by the Seller as a Trust Deed (Mortgage). Until a client receives
any principal return on the Note (cash received), the client does not have to
pay any tax on their equity. If a first or second trust deed (mortgage) is
“carried back” on the property being sold, and is payable at “interest only,”
then none of the principal is subject to any tax consequence until it is received
(cashed in) by the client. The interest received is taxed as ordinary income.
This is called an installment sale. The amount of cash that you do receive
as a down payment can be coordinated with the $250,000/$500,000 federal tax
exemption to reduce or eliminate your tax payment at time of sale. If you live
in one of the units of an income property and you treat it as your home, you
can also coordinate these programs along with a 1031 tax deferred exchange.
You could “buy down” into a smaller condominium, retirement home, or property
either where you live or anywhere in the country.
As you can see, taking the time to discuss and analyze
your exact tax situation prior to the time of sale can save you an enormous
amount of money. The money you don’t have to pay in taxes now can be used
by you to generate interest income to you until the time you receive cash and
have to pay the full tax consequence.
Wait a minute, I’m 65 years old and I can’t wait 30 years
for my money. I’m not the bank! This
is one of the many misconceptions of property owners who have owned their real
estate for many years. The reality is that a customized tax deferred installment
sale can be created for you. You can receive your principal (equity) in as
little or as long a time as you personally need. For example, you could create
a note for one, three, five, or even ten years or longer. The amortization
schedule (the amount of principal and interest received monthly to equally
payoff the debt) can be set up for thirty years (which is the standard time
used by most savings and loans and banks), but the due date (payment in full
date) can be whatever you establish. The length of time can be based on your
personal economic situation and financial planning.
Because the “carried back” principal amount is not subject
to any federal taxes until received, you will pay taxes only on the interest
you receive. What this means is that the percentage of your equity that may
have been subject to capital gain taxes is now invested and earning interest
daily. Check the financial section in your local newspaper today for the rates
for three and five year certificates of deposit (CDs). At the same time, look
at the interest rates that are currently being charged on first trust deeds.
You could probably obtain at least 1-2% more interest than from the CDs by
“carrying back” paper on an installment sale. Properly done, you could obtain a
higher, secure and controlled return on equity. Best of all, the interest
you received would be on both your tax-free equity (per IRS guidelines) and
taxable (deferred) dollars. With proper planning and professional advice,
you can structure any transaction to be beneficial to you.
5. Isn’t carrying the loan too risky? How would I know who is a
good credit risk?
This is an important question, particularly in today’s
market. With the Installment Sale concept, you do act as the lender or the bank
and must be very cautious about screening your potential “borrower.” Proper
advance planning will allow you to analyze the credit, financial statements,
and any other pertinent information of a prospective purchaser in exactly the
same way as a bank. When analyzing these documents, a Seniors Real Estate
Specialist®, along with your CPA and Attorney, will assist you in evaluating
and analyzing the credit worthiness of your particular buyer. Please keep in
mind that all of these recommendations are based upon the buyer/investor placing
a substantial down payment on the property.
6. What’s the worst thing that could happen to me if I carried
back some of my equity in a trust deed (mortgage)?
The very worst scenario is that you would have to foreclose
on the property. Then you would own it again. The Buyer would forfeit the down
payment and other moneys that were paid to you. A specialized service company
would do the entire foreclosure process. As horrible as this sounds, less than
3% of all the sellers with installment sales are ever put into this situation,
and most of those occur because buyers use very low down payments. Those owners
have very little equity to protect. I recommend that a First T.D.
(mortgage), and only a First T.D., secure any financing “carried back.”
Your financial plan will require a substantial down payment
and detailed credit checking, along with a complete analysis of the buyer’s
ability to pay. This puts you, as an investor, in a very favorable position.
However, there is always the possibility that changes in the market could occur
and a major recession or depression could hit. Then the question would be: “Am
I better off having this real estate or having my money in a financial
institution?” These questions require time, planning, and discussion to
evaluate the tax ramifications of selling for cash versus creating a personal
tax deferred program. Your REALTOR®, CPA, and attorney are invaluable here.
7. This sounds interesting. Could I keep my money out at interest
for a longer period of time?
This is often asked, and the answer is generally yes.
As long as the note is secured by the property, you keep your equity earning
interest and tax deferred. The interest rate you receive might have to be flexible,
depending on the marketplace and timing. If the interest rate is too high, the
buyer might want to refinance and pay off the loan. Many clients who sell their
property and become investors realize the continuing tax benefits of keeping
their trust deed current and interest rate flexible so that the buyer will have
a market rate incentive to make payments. They also discover that they can
carry their loan for a specific period of time and then renew it for another
specific period. Obviously, all of the installment sales we’re talking about
must have the proper protection clauses in them. The attached glossary gives
you some of the terms that will help to clarify these concepts. An acceleration
clause, notice of default, late charge provisions, and other protections
can be placed on all of these instruments giving you the right to control the
situation in the event the property might be resold.
8. What if I did an installment sale, and then I needed cash in an
emergency? Can I do this?
The answer to this is YES. You have two or
three options. One of the extraordinary benefits of an installment sale is that
you can carry back equity with beneficial tax consequences and at the same time
have an asset that, in the event of an emergency, is very liquid. A trust deed
(mortgage) in an installment sale that has been “seasoned” (meaning that
payments have been paid regularly for a period of time) can be borrowed against
by you or sold. First, you could sell the note, although you don’t have
to. The sales of any note and trust deed does create a tax problem. Most trust
deeds and notes are sold at a discounted value from as low as 5% to as much as
25%—sometimes even more. However, borrowing against it could be a very
creative way to solve your cash flow needs. Second, a bank or other financial
institution can generally lend you up to 50% or more of the current value of
the loan. So for every $100,000 of equity that you “carried back,” you could
borrow $50,000 of that amount fairly easily, and often at a very competitive
interest rate. The advice of your CPA or tax attorney is needed to determine
the proper procedures to meet your needs.
9. I’ve heard that a 1031
exchange can save me money. How does it
work?
People get confused between the tax-deferred exchange and
the installment sale. The 1031 exchange is basically designed for
trading income property. You would be exchanging your equity in one property
for another income producing property. To be tax deferred, it has to be of
equal or more value than the property you are selling or trading.
If you live in one of your units or decide to convert your
residential property into an investment property, an exchange could have strong
tax saving possibilities. You could also depreciate the property and create
another tax benefit. A 1031 exchange, however, is totally different from
the installment sale that I previously discussed. Again, proper analysis
of your individual situation by an experienced Realtor® along
with an accountant and tax attorney can help you to determine the value of a 1031
exchange. It doesn’t work for everyone, but for certain clients, it is the
only way and provides an absolutely exciting opportunity. The delayed exchange
allows you to find a Buyer for your property, place your equity with a qualified
accommodator, and then buy/trade for another property across town (or across
the country) and be totally tax deferred. You could still have the income producing
benefits of all your equity.
10. Why don’t I just refinance the property and live off the money?
Refinancing any piece of property can provide a cash flow
and will allow you to have money to use. The difficulty of refinancing and
living off the cash flow is that once that cash flow is gone, the property
becomes a negative equity situation. We’ll talk about negative equity a bit
later. Refinancing is not a benefit to most people. There are reverse annuity
mortgages that allow you to borrow against your equity by creating a loan that
is paid out to you in monthly installments, or you could receive the cash all
at once. It does not yet have the confidence of many seniors. One problem seems
to be that often there are very high costs deducted from the loan right at the
start. Please contact your local Reverse Mortgage Consultant for a free
interview before signing any documents.
11. Isn’t there a way that I could sell my property and stay here
until I’m ready to move?
Most people who ask this question are generally talking
about what’s called a Life Estate. It’s a technique where people can
sell their property to someone else, creating a tax savings situation in some
instances, and still reserve the right to live in the property for a specific
period of time or until they die. However, with property that has appreciated,
it is difficult to find a buyer who will go along with this for an unspecified
length of time because generally it’s not economically feasible. You also lose
control of your property. However, Life Estates can be very effective if
you own an income property—for example, a 6-8 unit building where you are
living in one unit. That unit could be left in your control as a Life Estate.
You could sell the property, get away from
the management responsibilities, and still have a place to
live for as long as needed. Again, a personal review with your Seniors Real
Estate Specialist®, Attorney, and your CPA are critical.
12. How does the 1997 federal tax exclusion work?
Currently, IRC. 121 allows any homeowner who is
selling his/her principal residence an excluded $250,000/$500,000 federal tax
exemption from the gain on the sale ($250,000—single person, $500,000—couple).
This exclusion is a powerful program that has been developed by the government,
giving most of us - particularly seniors - an opportunity to put all or most of
the profits from the sale of our primary residence into our pocket tax-free. To qualify, you must have owned the property and used it
as your principal residence for two of the last five years. The effective date
of this exclusion was May 7, 1997 and all sales closed after this date are
subject to the new laws.
13. There aren’t any more capital gains, right?
Yes, there still is capital gains tax!
This question is often asked because of the ever changing
federal and state tax situations. Since the 1930’s, there has always been
capital gains and subsequent tax. How the amount is arrived at, and at what
rate of tax, has been subject to change. Capital gain is the difference between
the basis in your property and what you’ll sell it for, less your selling
expenses. The 1997 Federal Tax revisions set the capital gains tax rate for
most property owners at 20% of the gross profit after expenses on property held
for 12 months or longer. If this is your personal residence, $250,000/$500,000
of gain is excluded from tax if you occupied it for two of the last five years.
Of course, on the sale of your principal residence or income units, you do have
to apply the federal tax exclusions before calculating the amount of any
capital gains.
If you have lived in income property over the years and
treated it as your home, it is very important to determine your original basis.
Why? Because the amount subject to capital gains is generally the amount of
profit between your original basis and the sales price of your current
property, less sales expenses and exemptions.
For Example:
1. A single client sold a home in
2. However, clients in
All real property is generally subject to a maximum federal
capital gains tax rate plus whatever your local state tax requirements call
for. In fact, in some instances, the sale today, when added to other sources of
income, might move you into a higher capital gains tax bracket. Capital gains
tax has not gone away. As you can see, it is imperative when planning the sale
of your property that you consult with a Seniors Real Estate Specialist®, CPA,
and Tax Attorney who are aware of all the tax consequences.
14. How can I get my equity to work for me and not against me?
This is probably the most critical of all the questions.
Because of the appreciation of real estate over the last 20+ years, most of us
who have owned property since then (or even longer) have substantial equity
today. Maximizing this equity (getting its highest and best use) and
converting it to a working asset for you is the exact reason for this report. Clients
have often said, “I own my property free and clear, so it costs me almost
nothing to live here.” This isn’t true, and here is an example of how your
equity can actually work against you instead of for you:
A property in
The real cost to live in any free and clear (unencumbered)
property must include a reasonable rate of return of the equity involved, plus
the actual hard expenses
(monthly out of pocket and maintenance), which are always
substantially higher than you think. The answer, then, creates some new
questions:
♦ Are you getting the best economic and emotional return on
your total equity in today’s market, or do you need to re-evaluate and plan for
tomorrow?
♦ Is the “real” cost of living in the property a profitable
use of equity? Or could you live somewhere else more reasonably and use the
extra cash for other needs?
♦ Would you get a better value for those dollars by
converting to another use?
♦ Do you have enough cash flow to enjoy the balance of your
life?
15. How can I be sure that I’m doing the right thing and am using
my equity to its optimum?
You might tell your clients that if they are over fifty and
their children were out of school, sell the family home. I realize that this
could be taken as a harsh statement, but as I have grown older, I believe it to
be absolutely true. What if they took their equity and purchased a duplex,
triplex or fourplex with an owner’s unit? It could be in the same neighborhood
that they’re living now or out in the country, maybe even in a golf community.
My point is that with this kind of residential income property, your equity
continues to work for you and your family still has a place to call home. It is
still appreciating, generating a positive cash flow, and providing security in
your senior years. This is just one of many ideas to think about. It’s never
too late to start utilizing all your assets to create a positive cash flow.
The purpose of the planning, discussion, and analysis we’ve
talked about in this Special Report are all brought to fruition here. Only by
taking the time to sit down with your Seniors Real Estate Specialist®, CPA, and
Attorney can you come to a proper, logical decision of what is right for you. Some actual case studies might help you to put this Special
Report and its data into perspective.
CASE ONE
A REALTOR® recently represented a client who owned a
property in
2. She carried back a tax-deferred $550,000 note secured by
a First Trust Deed (mortgage) at 8% interest, payable interest only, ($3,666)
per month for 5 years with an option to renew.
3. She purchased (putting 50% down) a smaller, nearly new
condominium in
4. She received the cash flow she needed to retire. She now
has a $3,666 monthly income from her equity in addition to other income. Plus,
she has a beautiful new home, instead of the 67-year-old home with a leaking
roof. To date, she has paid no capital gains tax on the sale and has placed
herself in a financially secure position.
CASE TWO
Now let’s discuss clients who, by making very quick
decisions without planning, put themselves into a very different position.
Recently, a retired couple in
Even though already successfully retired, the purpose of
the sale was to raise additional funds so that he and his wife, who was ill,
could relocate to a smaller home without invading any other capital funds. They
also wanted to give some money to their children. This could have been
accomplished much more effectively. Instead of paying Uncle Sam over $400,000
of their equity in taxes, they could have used the installment sale. Selling
the home for $1,900,000 with $600,000 down payment (tax free because of the
$500,000 exemption plus $130,000 in selling costs), they could have carried a
first mortgage for $1,300,000 at 8.5%. Approximately $320,000 in taxes could
have been deferred, and the couple would have received approximately $27,000
taxable interest per year on those deferred funds. Interest that could have
been used to fund their children and grandchildren’s financial future. Lack of
pre-planning, coupled with a quick decision without analyzing all of the ramifications
and foregoing competent advice from those professionals who were available to help, cost
this couple, their children, and grandchildren the use of a substantial amount
of money. Good planning, proper discussions, and good professional guidance
would have enabled them to take the right steps.
SUMMARY
While very few of us own million dollar properties and
these examples may not address the specific dollar value of your specific
property, the rationale remains the same.
Without proper planning and professional real estate
advice, mature clients are extraordinarily vulnerable at crisis decision-making
time. If you evaluate your individual situation in advance of the time of sale,
then whether you sell for cash or use some form of creative financing, you will
have the best situations and tools available to minimize your liabilities. All in all, with the proper planning, there are tremendous
tax and positive cash flow benefits available to all who were smart enough to
acquire property in the last twenty-five to fifty years. You’ve gone through
the traumas, the difficulties, and the sleepless nights to make sure that your
properties were cared for and paid for. When the time comes to sell your
residence or income property, doesn’t
it make good sense that you analyze, evaluate, and seek a competent professional
before you make any decisions? Whether you’re
going to sell in six months or six years, having a plan makes it so much
easier. Don’t forget our original premises
. . .
“A good real estate investment is worth A lifetime of labor”
And
“It’s not what you sell it for
that counts; It’s what you get to KEEP!”
REAL ESTATE TERMINOLOGY
BROKERAGE TERMS
Caravan: A group of
Realtors, usually from several offices, will join together to view properties
that are available in an effort to become more familiar with them prior to introducing
them to potential clients.
Co-Brokering: When one
broker lists the property and another office sells the property, they share the
commission through the listing office. The commission fee is not doubled; the
two offices share it.
Client: The client of
the broker is the individual who pays the fee for the brokerage service.
Customer: The
individual that has been attracted by the service provided.
Escrow: All deposits
held by the broker are held in escrow; a customer’s account, separate from all other
business accounts of the firm.
Home Inspections: A
potential buyer has an opportunity to obtain a satisfactory structural and
termite inspection within a reasonable length of time after the offer to
purchase has been accepted. The buyer has the ability to cancel the transaction
with the results of this inspection.
Listing: A property
that has been offered for sale by a broker.
MLS: The Multiple
Listing Service is a means of making possible the orderly dissemination and
correlation of listing information to its members
so that “realtors may better serve the buying and selling
public.”
Open House: An
opportunity to let the public view the property that is for sale during a
specific period of time without an appointment. The property is advertised as
an “open
house” and interested parties visit at random and talk with
the agent present.
Real Estate Broker: An
individual who is licensed by law to be employed by another, for a fee, to assist
in real estate transactions.
LEGAL TERMS
Administrator: Person
appointed by a court to take possession of property of a person who died without
leaving a will.
Closing: That date on
which the property is transferred from one individual to another.
Covenant: An agreement
between the parties in a deed whereby one party promises to do or not to do certain
acts with respect to the land (e.g. land used only for residential purposes).
Deed: The written
instrument by which the title to land is transferred from one to another.
Easement: The right of
use which one person may have over the lands of another (e.g. a right of way to
install, operate, and maintain utility lines).
Encroachment: The
intrusion of any improvement partly or entirely on the land of another.
Encumbrance: Any
interest in land held by persons other than the owner that will lessen the
value of the title (e.g. mortgages, liens, etc.).
Fixture: Personal
property that by state law becomes real property upon being attached to real
estate (e.g. drapery rods).
Legal Descriptions: A
property description, which by law is sufficient to locate and identify the parcel
of real property.
Lien: A claim of
charge on property of another for payment of some debt.
Life Estate: An
individual’s right to the use and occupancy of real property for life.
Offer to Purchase Property: A written instrument that is legally binding. It outlines
the buyer’s intent to purchase and under what specific conditions.
Power of Attorney: An
instrument in writing by which one person, the principal, authorizes another to
act for him or her in the specific action described in the instrument.
Purchase and
Recording: The noting
in the designated public office, usually the registry of deeds, of the details
of a properly executed legal document, such as a deed or mortgage.
Survey: A map of land
made by a surveyor showing boundary lines, buildings, and other improvements of
land.
FINANCE
Annual Percentage Rate (A.P.R.): The total amount of the finance charge including interest,
points, and all loan fees (e.g. escrow, processing, etc.) calculated as a
percentage of the borrowed amount and expressed as a yearly rate.
Application Fee: This
is a fee that may be charged by the lender to cover the costs of processing
your loan application. It is usually charged at the beginning of the application
process.
Appraisal: An estimate
of fair market value of a property prepared by a qualified real estate
appraiser.
Loan-to-Value (LTV) Ratio: The amount of the loan as a percentage of the property’s
appraised value. For example, an 80% loan is determined by subtracting a 20%
down payment from the property’s appraised value.
Margin: The margin is
the difference between the ARM index and the rate the lender charges.
Example: an index rate of 8% plus a margin of 2.5% could
result in a home loan rate of 10.5%. In some areas, the margin is referred to
as the factor. The fixed margin over the
index covers the lender’s operation expenses and profit
margin.
Mortgage: A mortgage
is evidence of the security for a loan. It is the document, signed by the
borrower, which gives the lender the right to the property if the loan borrower
failed to live up to the loan arrangement.
Negative Amortization: This
happens when the minimum monthly payment on an adjustable rate mortgage is not
large enough to cover the full amount of interest that
is due. The difference between interest owed and interest
paid may then be added to the loan’s principal balance, at the option of the borrower.
Origination Fee(s) (see also Points): Also called a Loan Fee, this is a fee assessed by the
lender for processing the loan. Most lenders’ charges are based upon the amount
of the loan. One point equals one percent of the loan
amount. The borrower at closing normally pays these fees. In some cases,
however, they may be paid by the seller or
shared by both parties. Also, the lender may “escrow” these
charges to be deducted from the mortgage amount.
Payment Cap: This cap
places an annual limit on the amount that a monthly payment can increase. This feature
is offered by some ARM lenders instead of an annual interest rate cap.
Point(s): One-point
equals one percent of the loan amount (see Origination Fee).
Assumption Fee: The
fee you pay the lender in order to assume someone else’s mortgage loan.
Assumability (Assumption of a Mortgage or Assumption of a
Deed of Trust): Agreement by a buyer to assume
liability under an existing agreement between seller and lender. Not all loans
or loan terms are “assumable.” The lender typically must approve the new
borrower.
Equity: The market
value of a property minus the total amount of any existing liens.
FHLMC (Freddie Mac): Federal
Home Loan Mortgage Corporation, an affiliate of the Federal Home Loan Bank,
which creates a secondary market in conventional
residential loans in FHA and VA loans by purchasing
mortgages from members of the Federal Reserve System and the Federal Home Loan Bank
System.
FNMA (Fannie Mae): Federal
National Mortgage Association, a federally sponsored private corporation, which
provides a secondary market for housing, mortgages.
Hazard Insurance: Insurance
protection for the borrower and the lender against property loss due to fire,
wind, or natural hazards. Many lenders require payment of the first year’s
premium as a closing cost.
Impound Account (also called Escrow Account in some
states):
This is an account held by the lender for payment of taxes,
insurance, and other periodic debts against a property. The borrower pays a specific
amount over and above the monthly loan payment, and the lender pays the bills
with the accumulated funds. Some lenders require an impound account for certain
types of financing.
Index: A published
interest rate composite used by lenders. Its movements determine interest adjustments
on adjustable rate loans.
Private Mortgage Insurance (PMI): This mortgage default insurance designed to pay the lender a
portion of the outstanding balance of a loan in the event that the homeowner
defaults. PMI may be required on certain types of loans; if so, the initial
premium is usually one of the closing costs, while subsequent premiums are
included in the borrower’s monthly payments. This insurance usually applies to loans
with only 10% down.
Refinance: The
securing of a new loan either to pay off an existing lien or mortgage on the
property or to access your equity.
Title Insurance: Insurance
protection against the consequences of a pre-existing lien or encumbrance on a
property that might be discovered after a change in ownership.
Underwriting: These
are standards set by the lender that the borrower must meet in order to qualify
for the loan.
©2003 SAREC All
rights reserved. 23