Charleston South Carolina Real Estate

Risky business

With all the talk in the media about defaults 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.  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 that need arise (you default).

Government backed loans include  FHA from the Federal Housing Administration, the loans guaranteed by the Department of Veteran Affairs or VA, and those backed by 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.

Published Wednesday, March 12, 2008 11:24 AM by Chris DeLoach, ABR, BIC