The intent of the following article is to provide an overview of mortgage industry loan purpose types and demonstrate methods that mortgage industry investors use to track and report loan purpose type statistics for loans in their servicing portfolio for risk management and seller performance monitoring purposes.
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The loan purpose type specifies the purpose for which the loan proceeds will be used. The loan purpose may be to purchase a home or to refinance an existing mortgage to obtain a lower interest rate or to get cash.
Mortgage industry investors track and report the distribution of loan purpose types in their portfolio in order to mitigate the risk associated with various loan purpose types. In general, buying a home represents less of a risk than refinancing an existing mortgage. Refinance transactions in which the borrower takes out little or no equity (cash) represents less risk than those transactions in which the borrower takes out a lot of cash.
Loan purpose type descriptions vary by investor. For the purpose of this documentation Loan Purpose Types listed on the Uniform Underwriting and Transmittal Summary form are defined.
A loan purpose type of Purchase indicates that borrowed funds are used to finance the purchase of a property.
A Loan Purpose Type of Refinance indicates that borrowed funds are used to finance the repayment of a debt from the proceeds of a new loan using the same property as security. Fannie Mae and Freddie Mac consider the current owner’s placement of financing on a property that is not financed as a refinance transaction.
- Cash-Out Refinance
A Refinance Loan Purpose Type in which the amount of money received from the new loan exceeds the total of the money needed to repay the existing first mortgage, closing costs, points, and the amount required to satisfy any outstanding subordinate mortgage liens. In other words, a refinance transaction in which the borrower receives additional cash that can be used for any purpose.
- Limited Cash-Out Refinance (Fannie)
A Refinance Loan Purpose Type in which the mortgage amount is generally limited to the sum of the unpaid principal balance of the existing first mortgage, closing costs (including prepaid items), points, and the amount required to satisfy any mortgage liens that are more than one-year old (if the borrower chooses to satisfy them), and other funds for the borrower’s use (as long as the amount does not exceed 2% of the principal amount of the new mortgage).
- No Cash-Out Refinance (Freddie)
The same as the Limited Cash-Out Refinance (Fannie) Loan Purpose Type including the allowable disbursement of cash not to exceed 2% of the new refinance mortgage. Even though a minimal amount of cash-out is allowed, Freddie chooses to maintain the legacy “No Cash-Out” description.
Home Improvement Loan
A Home Improvement Loan Purpose Type indicates that some or all of the borrowed funds are used to repair, remodel, renovate, rehabilitate, or otherwise improve the borrower’s home. When the financing for such improvements is a first mortgage, the transaction is treated as either a Purchase or a Limited Cash-Out Refinance transaction.
When the financing for the home improvements is a second mortgage, the transaction may be treated as a Purchase, a Refinance, or a standalone transaction (if the borrower is neither acquiring the property nor refinancing an existing debt in connection with the home improvement).
Construction to Permanent
A Loan Purpose Type of Construction to Permanent indicates that borrowed funds are used to finance or grant a long-term mortgage to a borrower to replace interim financing used for construction of a new home. It is not required that the institution providing the long-term financing be the same as the institution that provided the interim financing. The conversion of interim financing may be treated as either a Purchase or a Refinance transaction.
To be considered a Construction to Permanent financing transaction, one of the following must be met:
- The borrower is the primary obligor on the construction financing which is obtained through a legitimate financial institution; or
- The borrower is the owner of the lot on which the residence is constructed.
The following Loan Purpose Types are NOT listed on the Uniform Underwriting and Transmittal Summary form; however, are commonly used, in one form or another, throughout the mortgage lending industry. They are:
Debt Consolidation Loan
A Loan Purpose Type of Debt Consolidation loan indicates that borrowed funds are used to finance the replacement of multiple loans with a single loan. Typically, the new loan features a lower monthly payment and a longer repayment period. The debt consolidation loan is also referred to as a consolidation loan.
A Loan Purpose Type of Construction indicates that the borrowed funds are temporary financing’ (a.k.a. ‘interim financing’ and ‘short term financing’) used to finance the construction of a new home. Typically, the borrower makes draws from the lending institution, based on a predetermined construction estimate, to pay for construction services as they are rendered. The borrower makes payments on the construction loan until the construction is complete and other financial arrangements, (see Construction to Permanent ), to pay can be made.
A New Construction loan purpose type simply indicates that the loan is for a newly constructed home, typically a builder financed construction, which has never been occupied.
Home Equity Loan
A Loan Purpose Type of Home Equity indicates that borrowed amount is dependant upon the amount of equity in the borrower’s home. Home Equity is the amount of ownership that the borrower has built up through mortgage payments and property appreciation. A simple equation for determining Home Equity is the current market value of a home minus the outstanding mortgage balance. A Home Equity Loan borrows against the amount of home equity built up through payments and appreciation. A Home Equity Loan is also commonly referred to as a Second Mortgage. A Home Equity Loan is usually in a subordinate position to the primary mortgage loan.
Home Equity Line Of Credit (HELOC)
A Loan Purpose Type of Home Equity Line of Credit indicates that the borrowed amount is dependant upon the amount of equity in the borrower’s home. A Home Equity Line of Credit differs from the Home Equity Loan in that the borrower is allowed to obtain multiple advances of the loan proceeds at his or her discretion, versus receipt of the entire proceeds at closing, up to an amount that represents a specified percentage of the borrower’s equity in a property. Like the Home Equity Loan the Home Equity Line of Credit (HELOC) is usually in a subordinate position to the primary mortgage loan.
The “Reporting Mortgage Loan Purpose Type Statistics” section of this article details steps for creating a report that an investor may use to track and report the distribution of loan purpose types for loans that a seller has delivered to the investor. A disproportionate percentage of loans of a single loan purpose type from a single seller could represent a risk to the investor. The Sample Mortgage Loan Purpose Type Report in this article can be used as a model for a stand alone loan purpose type report or incorporated into a comprehensive Seller Scorecard report.
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