Chapter 15: Math & Trust Funds for the Loan Agent

Chapter 15: Math & Trust Funds for the Loan Agent By Dr. D. Grogan M.C. “Buzz” Chambers

Preview Many facets of the loan business include using various math computations. Many real estate students begin in the loan business and find that they need to become more proficient in math. This chapter covers the common areas of real estate mathematics used by loan agents, including the use of a financial calculator, loan-to-value (LTV) ratio, debt ratio, amount of interest paid throughout the life of a loan, reading a payment factor chart, loan comparison, and legal requirements for handling of trust fund accounting records correctly to maintain a DRE license.

Student Learning Objectives 1. Determine maximum loan amount and sales price, including LTV ratio. 2. Calculate the buyer qualifying ratios: front-end ratio and back-end ratio. 3. Read a payment factor chart to determine the total monthly payment. 4. Compare different loan amortization schedules for alternative loans. 5. Contrast alternative financing programs, including second and third trust deeds, and private-party carryback financing. 6. Use a financial calculator to obtain annual percentage rate (APR). 7. Determine the investor’s rate of return for a real estate loan. 8. Maintain DRE trust fund account record logs of client funds. 9. Differentiate between trust funds and non-trust funds. 10. Outline trust fund bank account requirements for record keeping.

15.1 Introduction Loan agents are expected to use mathematic calculations daily for loan purposes. Key strokes for a real estate financial calculator are part of the job. Reading manual payment factor and amortization charts are used. An example of a $425,500 appraised value is used in this chapter with different math.

15.2 LOAN-TO VALUE RATIO (LTV) The LTV is the amount of the loan in relationship to the value of the property, expressed as a percentage. Example: The LTV for the $425,500 appraised value for a property, where the buyer puts a 20% cash down payment, would be: $425,500 = the appraised value of the property - 81,100 = down payment of 20% $340,400= amount of new loan $ 340,400 ÷ $ 425,500 = 80% LTV

BORROWER QUALIFYING INCOME The monthly payment used to qualify a borrower consist of adding the principal, interest, property taxes, and insurance together. Even if the borrowers pay their own taxes and insurance separately, the mortgage loan broker uses the total PITI for loan qualification purposes. Any other items considered housing expenses such as mortgage insurance, homeowner association dues,flood insurance, and land lease payment , are added.

Front-End Ratio: • It is the total housing expense/debt in relationship to the borrower’s gross monthly income. • For example, using the $425,500 value with a 20% down payment, the loan amount is $340,400. • For a 30-year loan at 7.5%, the principal and interest payment is $2,380.13/month. • Property taxes are 1.25% x $425,500 = $443.23/month. • Insurance is $340,400 x .035% = $99.28/month • Total Housing Expense = $2,922.64 PITI

Front –End Ratio $2,922.64 / $10,852 = 27% borrower front-end ratio Front-end ratio should not exceed 29% Borrower 27% does not exceed the 29% maximum • Example (cont): • Gross month income of borrower = $10,852 • Total Housing Expense = $2,922.64

BORROWER QUALIFYING INCOME Back-End Ratio: Consist of total housing expense/debt plus installment and revolving debt, usually with payments of at least 6 or 9 months remaining. Example: The Martinez family has (1) a $389 monthly car payment with their credit union, (2) a car payment of $106 to ABC Car Sales, and (3) total credit card debt of $3,500 total unpaid balance, with a minimum of 5% monthly payment, or $150 per month. This results in $645 per month ($389 +$106=$150) for long-term non-housing debt.

Back-End Ratio: Add the Total Housing Expense of $2,922.64 And the Total long-term debt of $645/month For a total of $3,567.64 TOTAL DEBT. Divide the $3,567.64 total debt/ $10,852 gross monthly income with results of 33.0% back-end ratio. The 33% does not exceed the 38% maximum.

15.4 PAYMENT FACTOR CHART The mortgage loan broker may have to read a monthly payment factor chart, as shown in Figure 15.1. This chart shows both the 15-year, and 30-year payment factor for each $1,000. To read this chart, read down the column to locate the interest rate in question, which is located on the left side of the chart under Rate. Read across the heading to either the 15-year or 30-year P&I Factor. Then multiply the loan amount (not the sales price) by that factor. The answer will then need to be changed by moving the decimal point three places to the left, or by dividing the answer by $1,000. This monthly payment factor chart is beneficial when a financial calculator is not available or when a visual-learner borrower wants to “see” how to obtain the payment.

Amortization Table 12 ½ % 30 Years Loan - $155,700 • Look down the 30 year column for the monthly payment on $100,000 • Next, determine the monthly payment for $50,000, $5,000 and $700 using the same method • Then add the amounts together. Amount Payment $100,000 $1,067.26 50,000 533.63 5,000 53.37 700 7.48 $155,700 $1,661.74

$155,700 @ 12 ½% - 30 year The Principle & Interest Payment Factor for: 30 years is: 10.672578 x 155,700 = $1661.74 15 years is: 12.325221 x 155,700 = 1919.04 Difference per month $ 257.30

15.5 Amortization Comparison $425,500 sales price X 10% cash down payment $382,950 loan amount $425,500 sales price X 20% cash down payment $340,400 loan amount

Figure 15.2 Example 1: (Term: 15-year, fully amortized) (Rate: fixed, 7 ¼ % interest) Date Payments Paid Interest Principal Grand Totals After 2020 559,330.20 218,930.20 340,400 Event Start Date Amount Number Period End Date 1 Loan 10/1/2005 340,400.00 1 Points 1.500 5,106.00 Prorate Days 16 @ 68.55 1,096.84 Other Charges 0.00 2 Payment 01/31/2005 3,107.39 180 Monthly 10/01/2020

Figure 15.3 Example 2: (Term: 30-year, fully amortized) (Rate: fixed, 7 ½ % interest Date Payments Interest Principal 2020 Totals 28,561.56 19,511.51 9,050.05 Grand Totals After 2020 856,846.80 516,446.80 340,400.00 Event Start Date Amount Number Period End Date 1. Loan 10/1/2005 340,400.00 1 Points 1.500 5,106.00 Prepaid Days 30 @ 35.42 Other Charges 0.00 2. Payment 11/1/2005 2,380.13 360 Monthly 01/01/2035

Figure 15.4 Example 3: (Term: 30-year, fully amortized) (Rate: fixed, 71=2 % interest) paying one extra payment per year Date Payments Interest Principal 2020 Totals 30,941.64 14,786.38 16,155.26 Grand Totals After 2020 721,557.57 381,157.57 340,400.00 Event Start Date Amount Number Period End Date 1. Loan 10/1/2005 340,400.00 1 Points 1.500 5,106.00 Prepaid Days 30 @ 35.42 Other Charges 0.00 2. Payment 11/1/2005 2,578.47 279 Monthly 01/01/2029 3. Payment 02/1/2029 2,164.44 1

Figure 15.5 Example 4: (Term: 30-year, fully amortized) (Rate 7 1/2% interest) paying an extra 4 1/2% per year beginning in year 2 Date Payments Interest Principal 2020 Totals 53,291.40 2,712.35 50,579.05 Grand Totals After 2020 610,347.30 269,947.30 340,400.00 Event Start Date Amount Number Period End Date 1. Loan 10/1/2005 340,400.00 1 Points 1.500 5,106.00 Prepaid Days 30 @ 35.42 Other Charges 0.00 2. Payment 11/1/2005 2,380.13 12 Monthly 10/1/2006 3. Payment 11/1/2006 2,487.24 12 Monthly 10/1/2007

Figure 15.6 Example 5: (Term: 30-year, fully amortized) (Rate 7 1/2% interest) paying interest only for the first five years Event Start Date Amount Number Period End Date 1. Loan 10/1/2005 340,400.00 1 Points 1.500 5,106.00 Prepaid Days 30 @ 35.42 Other Charges 0.00 2. Payment 11/1/2005 Interest Only 60 Monthly 10/1/2010 3. Payment 11/1/2010 2,515.53 300 Monthly 10/1/2035 Date Payments Interest Principal 2020 Totals 30,186.36 20,621.51 9,564.85 Grand Totals After 2020 882,309.00 541,909.00 340,400.00

Summary: 3, 4, & 5 Example 3: A 30 year, fully amortized at 7 1/2% interest, adding one extra payment per year, payable with an extra one-twelfth per month increase in the monthly payment (equal to 13 payments per year instead of 12 payments per year, but paid in 12 payments). Example 4: A 30-year loan, fully amortized at 7 ½%, in which at the end of each year an increased monthly payment by 4 1/2% is calculated, so that the first 12 months’ payments remain the original contract monthly payment, but each subsequent year begins with a once-a-year increase in the monthly payment at month 13, month 25, month 37, month 49, month 61, etc. Example 5: A 30-year, fully amortized loan at 7.5% interest, with interest-only payments for the first five years and then fully amortized for the remaining 25 years.

Example 6: Comparing a (1)[90% LTV lst T.D. loan @ 7 ½% with PMI] to an (2) [80% LTV lst with a 10% LTV 2nd T. D. @ 9 ½ % with no PMI] The difference between the payment for the 90-10 and the payment for the 80-10-10 loan amounts to $171.54 per month. The savings for one year would amount to $2,058.48, and over a 30 year loan the borrower would save over $61,754.40 in interest. $2,743.50 PI 165.95 PMI (382,950 - .52% ‚ 12 = $165.95) $2,909.45 (P) + (I) + (MI) $165.95 of each payment each month is not tax deductible $425,500 - 80% = $340,400 @ 7.5% int. 30/30 $425,500 - 10% = $ 42,550 @ 9.5% int. 30/15 $340,400 the payment would be $2,380.13 PI $ 42,550 the payment would be $357.78 PI $2,737.91 PI

Example 7: Private-party carry-back financing, with three loans (Term: [(1) 30-year, fully amortized lst T.D.@ 7 ¾%], plus [(2) (2nd T.D. @ 9% amortized over 30 years, but due in 15 years] plus [(3) (3rd T.D. @ 11%, interest only/straight note, due in 5 years]) New 1st trust deed of $235,000 @ 7.75%, 30/30 (54% LTV) New 2nd trust deed of $125,000 @ 9.0%, 30/15 (29% LTV) New 3rd trust deed of $ 75,500 @ 11.0% interest only for 5 yrs (17% LTV) $435,500 Total loan amount (100% CLTV) -0- Down payment $435,500 Sales Price The payments would be: (principal, interest) 1st TD $1,684.29 PI 2nd TD $1,005.78 PI 3rd TD $692.08 I $3,382.15 PI

Computing the Rate of Return 1st TD of $235,000 @ 7.75% = $18,212.50 2nd TD of $125,000 @ 9.0% = $11,250.00 3rd TD of $75,500 @ 11.0% = $8,305.00 $37,767.50

Example 7 The difference between the 90% loan with PMI and the private-party carry-back finance is $472.70, or $15.76 per day. When borrowers are in a position in which they are able to pay a higher payment, the private-party carry-back loan may be more advantageous than the traditional 90-10 with PMI. With no cash for a down payment, the borrower needs to finance the closing costs and the loan amount, which enables a borrower to purchase a home rather than rent and to save cash for a future purchase. An additional savings to the borrower is that after 5 years, when a borrower’s income typically has increased, the third trust deed would be paid off, which could lower the monthly payment by $692.08. Beginning the sixth year, the monthly payment would include only the first and second trust deeds. In another ten years, the second trust deed would likewise terminate.

Example 8: Two-step mortgage, private party carry-back (Term: [(1)existing fully amortized lst T.D.@ 7 ½%, 25 years remaining, paid off in one year upon refinancing], plus [(2) New 2nd T.D. @ 10% straight note, due in one year]) Step 1: Value: $425,500 Total loans would be $121,000 ($96,000 first amortized for 30 years + $25,000 second due in one year) or a new combined loan to value (CLTV) of 28%. Pay off all debts, the car, and credit cards ($10,974 + $3,341 = $14,315) Because of the age of the property, the private party lender may require items that enhance the value of the property, such as replacing the carpet and air conditioner. Funds available for closing cost (investor fee, broker fee, credit report, escrow, title insurance, recording fee, etc.)

Example 8: Two-step mortgage At the end of the one-year period, the loan broker could assist the borrower in obtaining a refinance loan that would demonstrate 21 months on the job, a credit score in the mid-600 range, with increased income—the $2,340 base pay, plus the $1,340 social security income, for a total of $3,680. The new loan would include the current unpaid balance on the existing first trust deed of approximately $96,000 plus $27,500 that includes the current unpaid balance on the second plus the closing costs needed to close the loan. • Help a borrower at the current time on this loan and be in a position to do a refinance in one year, when the second trust deed becomes due. • Allow the borrower to reduce current debts and provide time to improve the FICO score. • By the end of the first year, the borrower could show proof of making the payments on the first trust deed on time, with no late payments during the past 12 months. • The borrower would have established a longer period on the job, with 21 months instead of 9 months.

Example 8: Two-step mortgage(cont) This new loan of $128,000 at 71/2 % interest, amortized over 30 years, would have a monthly payment as follows: $894.99 principal and interest 102.48 property taxes 176.00 homeowner association dues $1,173.47 a PITI $1,173.47 / 3,680 = 31.88% front-end and back-end ratio The borrower would end up with no debt. The new loan would confirm to FNMA guidelines with very conservative new LTV of 30% ($128,000 ‚ $425,500).

15.6 Financial Calculators Hewlett-Packard (www.hp.com/country/us/en/prodserv/calculator. html) Texas Instruments (http://education.ti.com/educationportal/sites/US/productCategory/us_financial.html) Calculated Industries: Real Estate Master (www.calculated.com/cat11/Real+Estate+Calculators.html)

FINANCIAL CALCULATORS A. The mortgage loan broker makes use of calculations as an ongoing process in the daily activity of the job. The DRE allows applicants for the real estate licensee examination to utilize a calculator that they are comfortable using, but they must also become proficient in the key strokes for the required daily applications. B. The majority of real estate licensees use one of 3 calculators. 1. The Hewlett-Packard series of calculators has been predominantly used by those working in financial institutions, including stock and brokerage houses and for advanced appraisal techniques. Today, nonresidential real estate persons tend to stay with HP calculator. 2. The Texas Instruments Business Analysis (BA II) has been predominantly used at 4-year universities for finance majors and those working primarily with stocks and bond calculations. 3. The Real Estate Master, by Calculated Industries, is used primarily for everyday real estate calculations by real estate salespersons and brokers to determine loan payment, unpaid loan balance, front-end and back-end ratios and buyer qualifying (hence, the name of their calculating is Qualifier Plus).

BROKER TRUST ACCOUNT FUNDS 1. Definition of trust funds includes: a. Funds received on behalf of others b. Creates a fiduciary responsibility to the owner of the funds c. Any thing of value received by a licensee for another in the performance of a real estate activity d. Funds used in the performance of an act for another e. Funds being held for the benefit of others 2. The funds include: a. Buyer’s initial deposit on an offer to purchase b. Buyer’s up front deposit to pay for fees such as a credit report c. Principals money used to pay for points, fees or charges d. Promissory notes received, held for or payable to or for a principal, secured directly or collaterally by a lien on real property e. Deposits made into an escrow account, title company account, real estate s ales broker, or property management trust fund account f. Uncashed items (checks, notes) instructed to be held by a principal

BROKER TRUST ACCOUNT FUNDS (cont) 3. Non trust funds are those that belong to the broker or business office: a. General operating funds b. Rents and deposits for broker-owned real estate c. Funds used for broker-owned loans on notes d. Commissions earned from collection of principal funds, placed into the trust account, then calculated as a fee and paid from the principal’s balance from the trust fund i. Earned commissions may remain in the trust account up to a maximum of 30 days. ii. Earned commissions must be paid out to a broker, not directly to a salesperson or employee of the broker. 4. Benefit of having a trust account a. Physical separation and accounting control over trust funds avoids commingling of broker funds with the funds of the principal b. Trust funds cannot be frozen under pending litigation against the broker or during probate of the broker’s estate Each owner has FDIC insurance up to $125,000 rather than just one broker bank account.

Bank Deposit Trust funds must be placed into broker trust account Broker may deposit personal business funds into trust account: Up to $200 maximum To maintain bank charges for the account

Trust Bank Account Must be a Demand account No prior notice required to withdraw funds Non-interest bearing account Neutral depository Must reconcile at least once each month

Trust Account Withdrawals Requires signature of designated broker Salesperson licensed to the broker needs written authorization to sign the account Unlicensed employee may sign if Fidelity bond indemnifying the broker Fidelity bond for maximum amount of funds accessible to the employee at any time Broker may not take anticipated commissions, only funds actually earned and received

Records Required: Date funds received, deposited & disbursed Name of party received from & disbursed to Amount of funds received & disbursed Check number received & disbursed Form of funds received: cash, note, check Interest earned for principal Balance in account for EACH principal on daily basis and for the entire account

Trust Fund Law for Licensee “In the business” Acquisition for resale, sale or exchange with the public of 8 or more notes in 1 year Transaction must name the broker Salespersons prohibited from dealing direct with the public Broker must licensed by DRE

Trust account must: Designate the account as a TRUST ACCOUNT Name the broker as TRUSTEE Be maintained at a bank in California Account servicing for an investor of a note: FNMA, GNMA, FHLMC, FHA, DVA Trustee of a pension fund over $15,000,000 Licensed residential mortgage lender or servicer Licensed real estate broker selling the loan

Records Maintained Broker must retain for three years Keep copies of all receipts & checks After 3 years, broker should check with IRS All trust account records must be available to DRE for examination Non-compliance with trust funds may result in: Revocation or suspension of DRE license Financial liability to the principal for damages

Advance Fees Handler: A broker who claims, demands, charges, receives, collects or contracts to collect funds while employed to obtain loans. Funds: Any amount of money collected to cover the cost of services performed in arranging a loan.

DRE Advance Fee Requirements: A written advance-fee agreement. Materials submitted to DRE Commissioner at least 10 days prior to use. Approval of agreement & materials. Fees must be payable to the broker. Exemption: Appraisal fee & credit report fee are not deemed an advance fee.

Reconciliation of Accounting Records • Name of the agent and the principal. • Description of services rendered. • Identification of account where funds placed. • Amount of advance fee collected. • List names & addresses of persons for the loan. • Amount collected or disbursed from the fees: • Services rendered • Commission paid to field agents & representatives • Overhead costs and profit

Threshold Account When a broker meets the business activity of: 20 or more loans aggregating $2 million. Loan collections aggregating $500,000 on behalf of a non-exempt lender.

DRE Threshold Account Quarterly trust fund status report with DRE Annual Trust fund report file with DRE Annual review of trust fund financial statements by DRE Broker must furnish each principal: Verified copy of accounts, quarterly Verified copy of accounting when the contract is completed

TRUST FUND ACCOUNTING 1. When a broker maintains a trust account, certain records must be kept. Brokers are instructed to maintain generally accepted accounting principles in the handling of a trust account to be in compliance with DRE Regulation 2831. The record should set forth in chronological order the following information in columnar form: · Date funds were received · Name of party from whom funds were received ·Amount of funds received ·Date of deposit of the trust funds ·Check number and date of trust fund disbursement ·Name of entity to whom trust funds were disbursed · Daily balance for each separate principal’s funds · Daily balance of trust account 2. In addition to keeping records for all funds received, the broker must keep a separate record for each beneficiary and transaction. 3. The broker must account for all funds that have been deposited into the broker’s trust account and any interest earned on the trust funds on deposit.

Audits & Examinations Broker must furnish authorization for examination of financial records of trust funds. Broker pays cost of audit if final desist & refrain order, or after disciplinary hearing awarded finding broker in violation of real estate law. Commissioner may seek recovery of costs.

Trust Fund Violations Restricted License: B & P Section 10148 Broker pays estimated average hourly salary for all persons performing audits, including travel time to and from auditor’s work. Respondent has 60 days from receipt of invoice to pay. Commissioner may suspend the restricted license pending a hearing if payment not made timely. Suspension remains until paid in full.

Chapter 15: Math & Trust Funds for the Loan Agent