Chapter Six

Real estate lending

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Learning objectives

1. Explain what real estate loans are

2. Explain how real estate loans are evaluated
3. Explain, with the help of specimen real estate loan
applications, how the principles of lending are applied in
practice
4. Enumerate the precautions to be taken in assessing these
types of loan applications
5. Outline the trends in real estate credit
6. Explain the pricing aspect of real estate loans
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Introduction

• Real estate lending can be defined as loans that are

made for:
• The purchase of a home, or
• To fund improvements to a private residential block
• Also known as residential mortgages
• Generally for longer terms, i.e. 10– 30 years

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Evaluating real estate
loan applications

• Some basic terms need to be understood in real estate

lending:
• Property: Anything that is owned or controlled, e.g. land,
furniture, clothing, etc.
• Real Estate: Earth, land and man-made hereditaments (items
that can be inherited)

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• Interest in Real Estate:
• Freehold: Fee Simple Interest, Joint Tenancy (transferred to
remaining owners upon death), and Tenancy in Common
• Leasehold: Lessor and Lessee contract
• Encumbrances and Liens:
• Encumbrance: Party, other than owner, has interest in the
property, e.g. utilities
• Liens: Party, other than owner, has financial interest in the
property, e.g. debt security
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• Promissory Note and Mortgage:
• All real estate borrowers sign a promissory note specifying
repayment details
• Mortgage creates an enforceable lien over the property
backed by a promissory note

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• Title Deeds:
• On the sale of real estate, title is transferred on a written deed
• Titles can be in the form of be common law, Torrens, Company,
Strata and Community
• Public Records: Any interest held in real estate is on public record to inform
interested parties that the land is owned, and by whom

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Valuation of property

• Loan features:
• Loan-to-Value (LVR) not to exceed 80% without mortgage insurance
• Valuation only conducted by approved valuers (Bank-appointed
valuers tend to be very conservative)
• Three traditional approaches
• Market Value Approach
• Cost Approach
• Income Capitalisation Approach

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• Market Value Approach
• Very popular method based on recent sale values of comparable properties
• Potential problems
• May have limited comparability
• House’s condition may vary considerably
• Quality of foundations may differ greatly
• Sale reflects historical trends and may be inaccurate for current market conditions
(eg, infrequent sales outside of the city)
• Are any special features apparent, e.g. on sacred site or other sentimental value?

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• Cost (Summation) Approach
• Step 1 – Value of land alone is assessed using recent property
sales
• Step 2 – Adds value of all improvements
• Step 3 – Subtracts allowance for depreciation, wear-and-tear, etc.
• Step 4 – Adjustments for any other matters, e.g. desirability of
location
• May be disputes over costs used
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• Capitalisation Approach (Used for Investment Real Estate)
• Uses ratio of rental income from comparable properties and
adjusted for any specific differences/characteristics
• Relies on net income (gross income minus expenses) to determine
yield
• Also known as ‘years purchase method’ or ‘net income multiplier
method’

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Step-by-step evaluation
of home loans

• Five steps involved:

• Step 1 – Applicant completes prescribed form including privacy
waiver.
• Step 2 – Determine loan eligibility and serviceability, arrange
valuation and determine interest rate, fees, caps, etc.
• Step 3 – If loan approved, send loan offer document to borrower. If
loan declined, use bank’s standard letter due to possible legal
implications.

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• Step 4 – If applicant proceeds, gather all legal and title
details from applicant’s solicitor and other institution if
refinancing involved. Applicant must sign mortgage
documents in presence of authorised bank officer.
• Step 5 – Arrange settlement of loan transaction with
applicant’s solicitor. Debit stamp duty and other
fees/charges/taxes from nominated mortgage account.

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Financial appraisal of real
estate loans

• Can applicant comfortably service loan repayments on their

income?
• Three factors in loan instalments
1. Amount of loan
2. Period of loan
3. Applicable interest rate (sometimes with sensitivity analysis)

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 Example of a real estate loan
application

• Sourced from www.commbank.com.au

• Details requested by lender include:
• Purpose of loan, i.e. owner-occupied or investment (How do these differ?)
• Property details, i.e. address, price, access for valuation, contractor/builder,
etc.
• Type of loan requested, repayment options, whether mortgage insurance
required and proposed insurance

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• Applicant’s personal details including name, address and financial
position
• Legal elements including purchaser’s solicitor/conveyancing firm,
and validity of property's title. Important to note that this document
does not constitute an offer to lend
• Applicant’s gross monthly income, LVR, mortgage insurance (if any)
• Lender’s decision about loan completed

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Precautions in granting
real estate loans

• The following are some precautions that the lender

should consider:
• Accurate factual information such as valuation, dimensions of land,
title, etc.
• Information about recent local sales
• Vendor has proper title to transfer
• For new housing, permissions granted from council, water authorities,
electricity, telephone and determining suitability of site for construction

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• Verifying that applicant has not withheld information such as health
or employment (although may be difficult to obtain)
• Despite lender’s best efforts, default may be possible from problems
with health, injury, employment, family disputes, etc.
• Ensuring loan officer has complied with the many complex lending
procedures
• Ensuring loan officers are aware of all lending policy changes

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Trends in real estate credit

• High borrowings from low interest rate environment

• Mortgage originators have seized significant market
share
• Considerable pressure has been placed on interest rate
margins
• Greater emphasis on fee income

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Pricing and structuring of real
estate loans – loan pricing

• Loan Pricing
• Loan pricing refers to the:
• Interest rates
• Fees
• Other terms imposed by the lender
• Greatly affected by the sources and costs of funds and any capital charges
required
• Lender borrows from surplus units (those with savings to lend) to deficit units
(those seeking to borrow funds)

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Traditional loan pricing method

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Calculation of interest on loans

• Fixed: Generally set for 1–5 years though

increases lender’s risk
• Floating (variable): Generally altered at bank’s
discretion in line with Official Interest Rates

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Bank fees

• Bank’s shown great fee-generating creativity including

fees for:
• Loan establishment, service, loan switching,
progressive loan drawing, lodgement, settlement,
statement,early repayment, etc.

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Determinants of interest
rates on home mortgages
• Rates largely determined by supply/
demand forces in property market and in funding
sources
• Monthly Repayment (MRP) calculations
MRP  (P x R x Y)  Z

Where P = Loan Amount Z = Y–1

R = Interest Rate 12 t = Time in years
Y = (1+R)t x 12
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Pricing and Structuring of
Real Estate Loans

• Loan structuring
• Refers to repayment patterns and any other term agreed upon
• Includes loan security and any covenants
• Usually has the following documents
• A promissory note
• Mortgage deed
• Letter of guarantee
• Property’s sale deed
• Assignment of other collateral (if required)
• Loan agreement with terms and conditions
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Pricing and Structuring of
Real Estate Loans

• Terms and conditions

• Repayments: Amount and frequency
• Interest Rates: Fixed, variable or variant
• Security/Insurance: Details of assets to be mortgaged and any insurance
details
• Default Clause: Actions available in the event of default
• Pre-Payment Clause: Pre-payment procedures and costs
• Fees: Schedule of fees and payment timing
• Stamp Duty and Government Charges

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