With all the talk in the media about default and foreclosures, it’s not a bad idea to have an understanding of how loans are issued and how banks are protected when they issue loans.  Understanding this help us understand why it is getting harder to get a loan – even for well qualified folks like you.

Clearly, lending can be a risky business.  Lenders have no choice but to be careful.

 In order to encourage banks to lend money for mortgages, the government provides guarantees through three major lending entities: the FHA, the VA, and the FMHA. In addition to the government guarantees that are available to banks, there is also private mortgage insurance or PMI.  As long as the lender has more than 80% of equity exposure, they will require some sort of assurance to guarantee the loan.  In other words, until you have 20% equity in your home, you will need private mortgage insurance unless your mortgage is protected through one of those three quasi governmental entities mentioned above.

Mortgage lenders incur losses or have the potential for incurring losses during any default and foreclosure.  Lenders issuing loans where the buyer puts down less than 20% require private mortgage insurance for nongovernment backed loans and require that this insurance be paid for by the borrower.

Of course, this will increase your monthly payment by the amount of that insurance premium.  Once you reach 20% equity in your home,   you are no longer required to pay private mortgage insurance.  The 20% figure is the amount that banks have determined, over years of experience,  is necessary in order for them to recover the costs of liquidating their residential real estate backed loans (selling your home on the open market) should the need arise (you default).

Government backed loans include  FHA or the Federal Housing Administration, the Department of Veteran Affairs or VA, and the Farmers Home Administration or FMHA.  These are not direct lenders but these are entities that provide insurance to protect commercial lenders when they issue loans to borrowers who qualify for one of these agency backed loans. Of course, the big benefit to the borrower is that they are not required to pay for private mortgage insurance or PMI - plus, they may be able to obtain a loan with little or even zero down. There are costs to the borrower when using these agencies - but those costs are usually offset by the benefits.

In a nutshell, the FHA is designed to help low to moderate income people obtain mortgages, the VA offers loans to veterans or active-duty personnel, and they FmHA is designed for people who meet certain income requirements that want to buy in very rural areas.

Note: most offers to purchase will disclose the sort of lending to be sought by the buyer. The seller may factor in the more lengthy process and higher demands on the seller when considering accepting an offer from a buyer using a government-backed loan. Usually it doesn't have a great impact on whether or not the offer will be accepted; but, in markets that are very fast-moving (strong sellers markets) it has been known to create a disincentive for the seller to accept an offer from someone using a government-backed loan.

Let’s first eliminate a misunderstanding. Banks do not GIVE mortgages.

If you have a home with a mortgage, the bank owns the mortgage.  How did they get it? You GAVE it to them.  Most people say that they are going to get a mortgage when in fact they are really giving a mortgage.

A mortgage is the legal documentation that gives the lender the right to foreclose.   If you choose not to pay, the mortgage provides the steps the bank will follow in order to regain their investment by selling your house.

You give a mortgage to a bank which gives the right to take your property in exchange for your failure to make your loan payments (so they may resell that property to regain their investment).

The bank owns the mortgage – you don’t.

When you purchase a home and you use a lender, the lender will require some sort of promise from you that you will repay a loan.  That promise from you is your “bank note”. Don't confuse this with the term mortgage. The note is your IOU while the mortgage is the lender’s right to compensation.  (Note:  A Deed of Trust, for practical purposes, is nearly the same as a mortgage). 

You might ask, “… if the bank has a mortgage on my home, do I own my home or does the bank own it? “   That depends on where you live (which state). Whoever owns the title to the property is the owner of the property.

In our state, the state of South Carolina, we are a lien theory state.  That is, the homebuyer owns the title to the property at closing (close of escrow); but, the bank places a lien on the property (described in the mortgage language).

There are circumstances in other states where the bank retains title to the property until the entire mortgage payments are paid -- at which time the title is issued to the buyer. This may also be the case with certain types of governmental owned properties such as those foreclosed on by the VA (VA Repo) and placed on the market for resale. It is possible, in a case like this, that the VA will retain the title to the property until the second loan is re-paid. Also, with certain forms of owner financing, the previous owner may retain title to the property until all payments are completed (example: contract for deed or land contract).

Chris DeLoach, MAT, MEd, ABR, BIC