Vail Daily column: Lending rule could help locals in deed restricted housing
It’s a towering challenge to many to afford a home in Eagle County, and the deed-restricted programs to keep a stock of housing available and affordable have been an enormous help to several hundred families.
However, one cost the county and local governments cannot make go away has been the cost of mortgage insurance. If a buyer has less than 20 percent down payment, then he will end up paying a monthly fee called mortgage insurance. What mortgage insurance does is provide a type of insurance policy for lenders so that if there is a foreclosure and the lender can’t recoup all of the money loaned, then the mortgage insurance company will step in with a check to make up the difference up to a certain limit — generally 30 percent of the original loan amount maximum.
A little workaround
But there is a little-known way for borrowers in deed restricted housing to get out of paying mortgage insurance. Fannie Mae and Freddie Mac — which ultimately end up owning about 90 percent of the mortgage notes in the U.S. — have buried, deep in their 1,200 page rule books, a small paragraph discussing how a deed restricted home can be valued on an appraisal for a refinance. That paragraph states that for a refinance, the property may be appraised as a free market unit with no deed restrictions for purposes of determining loan-to-value. The only limitation is that the deed restrictions have to go away in the event of a foreclosure and lack of redemption by a borrower of the local governing entity that put the restrictions in place. If that happens, then the lender owns the home with no deed restrictions and it could be sold as a free market unit.
So, if someone bought a deed restricted home, meeting the above requirement, for say $300,000 and put 5 percent down, then he or she would be paying mortgage insurance based upon a 95 percent loan to value loan. In addition, the adjustments to the interest rate are based that loan to value, which always means he or she is paying a higher rate to start with than someone with 20-30 percent down, and he or she is paying mortgage insurance.
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If he or she refinances the home, say, six months after it is purchased, then it can be valued for appraisal value purposes — not resale purposes — at what the unit might go for if it was across the street and did not have deed restrictions. This means that if, for example a Miller Ranch home, was located in Homestead or the Reserve, then it might appraise for $50,000 to $100,000 more. If the home in question appraised at $375,000, then the loan to value would be calculated at 80 percent and there would be no mortgage insurance on the new loan.
While this is great news for homeowners, it does require some common sense and restraint on the part of borrowers and others in the lending business. The paragraph in question really should have been a few sentences longer and limit borrowers from borrowing more than they could ever sell their homes for, but it does not. In theory, if a homeowner otherwise qualified, then he or she could likely borrow far more than he or she could ever sell the home for, which eventually means financial disaster for the homeowner when he or she goes to sell, as he or she will still owe the difference.
Our company has discussed this issue internally, and we are not in the business of getting our clients in over their heads to make a buck and have elected a policy that we will never take an application for a loan that, even though it could likely get approved, would put the borrower in a position of owing more than we all know the property will likely ever be worth. I can’t say that some online lenders or certain mortgage brokers out there would take advantage of this situation and deliberately counsel their borrowers to get in such a predicament.
Consideration is necessary
Abuse of this scenario could also be a bad thing for affordable housing, as the governing entity that initially put the housing project together has to either pay off the loan, regardless of the amount, and redeem the property or let the deed restrictions lapse.
Not every lender who sells loans to Fannie or Freddie is either aware of this rule or, if they are, then they may not subscribe to offering the option. I’ve done this with locals, and have two more in the works right now, and it can be done.
Chris Neuswanger is a loan originator at Macro Financial Group in Avon and may be reached at 970-748-0342. He welcomes mortgage related inquiries from readers. His blog and a collection of his columns may be found at http://www.mtnmortgageguy.com.