The Mortgage Lending Process
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Chapter 3
The Mortgage Lending Process
Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Overview Chapter 3 discusses: • Roles of the mortgage professional • Pre-qualification and pre-approval and important differences between the two • The loan process • Standards relating to income, credit history, and net worth • Housing expense ratios and total debt service ratios using secondary market guidelines
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Chapter 3: The Mortgage Lending Process
Key Terms • • • • •
Assets Credit History Credit Scoring Debts FICO Score
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• Housing Expense Ratio • Liabilities • Loan Originator • Loan Processor • Loan-to-Value Ratio (LTV) 3
Chapter 3: The Mortgage Lending Process
Key Terms • • • • •
PITI Point Pre-Approval Pre-Qualification Reserves
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• Servicer • Stable Monthly Income • Total Debt Service Ratio • Underwriter
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Chapter 3: The Mortgage Lending Process
The Role of the Mortgage Professional • Work for any bank, credit union mortgage lender, mortgage investor, or mortgage broker • Duties vary depending upon the size of the company • Important to understand basics of mortgage lending and what the duties may be depending on the type of lender you work for Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Functions of Mortgage Professionals In addition to typical office duties and paperwork: • Origination • Underwriting • Servicing
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Chapter 3: The Mortgage Lending Process
Functions of Mortgage Professionals • Originating: The process of making or initiating a new loan • The Processor: Typically responsible for verification of the information contained in the file (such as sending out employment verification forms), and also coordination of the various aspects of the loan (such as working with the title company) Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Functions of Mortgage Professionals • Underwriting: The process of evaluating and deciding whether to make a new loan • Servicing: The continued maintenance of a loan after the loan has closed • Many mortgage companies offer a combination of these services to their clients
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Chapter 3: The Mortgage Lending Process
Getting a Buyer Approved—In the Past
People completed loan applications only when ready to buy a particular home • Why loan applications ask for detailed information about prospective buyers so lenders can make informed decisions about whether to grant credit
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Chapter 3: The Mortgage Lending Process
Getting a Buyer Approved— Today
• Growing trend toward pre-approving buyers for loans • Pre-approval can be a useful negotiating tool • Pre-approval is NOT the same as pre-qualifying buyers −The two terms are not interchangeable
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Chapter 3: The Mortgage Lending Process
Pre-qualification • Process of pre-determining how much of a loan a potential home buyer might be eligible to borrow • May be done by an agent or the lender • Does NOT guarantee approval • Not binding on the lender − Lender simply saying it looks favorable that the buyer will eventually get approved Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Pre-approval • Process by which a lender determines if potential borrowers can be financed through the lender, and for what amount of money • Borrower completes several steps of the loan process • Lender is stating the borrower’s situation has been checked-out • Provided all circumstances stay the same, willing to loan a person up to a certain amount of money • Powerful negotiating tool
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Chapter 3: The Mortgage Lending Process
Loan Approval Process The real estate loan approval process can be broken down into four steps: 1. 2. 3. 4.
Consulting with the lender Completing a loan application Processing a loan application Analyzing the borrower and property
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Chapter 3: The Mortgage Lending Process
Consulting with the Lender
• Do not interject your own opinion into the situation • Always let clients or customers have the final say as to how they apply for a loan and with whom • If you represent more than one company program, always consult with your mortgage broker or employer regarding policies in all areas before giving any type of advice or recommendation
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Chapter 3: The Mortgage Lending Process
Common Fees Associated with Real Estate Loans
• Application fee • Pulling buyer’s credit bureau report • Securing a property appraisal report • Preliminary title report • Completing inspections − If loan closes, title insurance, recording fees, and origination fee (aka loan service fee)
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Chapter 3: The Mortgage Lending Process
Completing the Loan Application
• The loan application is the form lenders require potential borrowers to complete, listing all pertinent information about the borrower and property • The same application is often used for pre-approvals, with the same information being asked about the borrower, since the lender anticipates a pre-approval will eventually lead to a loan
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Chapter 3: The Mortgage Lending Process
Data Needed for Application Will vary by lender, but usually includes: • Sales contract for home borrower wants to buy • Two years of residence history • Two years employment history • Income Information Continued on next slide
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Chapter 3: The Mortgage Lending Process
Data Needed for Application • • • •
List of assets List of liabilities Copy of gift letter, if applicable Certificate of Eligibility for VA loans and DD-214, if applicable • Sales information regarding present home • Any other info the buyer feels is relevant or is requested by the lender
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Chapter 3: The Mortgage Lending Process
Loan Application • Borrower typically completes during the initial consultation with lender • Designed to elicit responses that detail borrower’s history, trends, and attitude as a means of trying to predict future loan repayment behavior
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Chapter 3: The Mortgage Lending Process
Parts of the Loan Application • Section I: Type of Mortgage and Terms of the Loan • Section II: Property Information & Purpose of the Loan • Section III: Borrower Information • Section IV: Employment Information • Section V: Monthly Income and Combined • Section VI: Assets and Liabilities Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Parts of the Loan Application • Section VII: Details of the Transaction • Section VIII: Declarations • Section IX: Acknowledgment, Agreement, and Borrower’s Signatures • Section X: Information for Government Monitoring Purposes
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Chapter 3: The Mortgage Lending Process
Processing the Loan Application
Other pertinent information about the buyer:
• Check stubs or W-2 forms • Copies of bank statements and other original documents • Verification forms sent out to buyer’s employer, banks, other creditors, and any previous mortgage lender. • Credit report will be ordered and a preliminary title report prepared • An approved appraiser will be contacted to appraise the property Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Analyzing the Borrower and the Property
When reviewing a borrower’s loan application, the lender considers five main categories: 1. 2. 3. 4. 5.
Capacity Collateral Credit Character Conditions
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Chapter 3: The Mortgage Lending Process
Analyzing the Borrower and the Property
The lender will also want to know the source of the buyer’s down payment: • Savings, sale of a prior home, or gifts are all acceptable sources • Buyer usually can't use borrowed funds or gifts for the first 5%
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Chapter 3: The Mortgage Lending Process
Underwriting Process • Involves reviewing the information it contains and verifying items as necessary • When lender receives the credit report, verification forms, preliminary title report, and appraisal, a loan package is put together and given to an underwriter • The underwriter is usually the final decision maker on a borrower's loan application • Process can be automated or done by an individual who works for the lender Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Automated Underwriting • Information from a loan applicant is fed into a computer • An evaluation comes back within minutes advising the lender to: • Accept the loan applicant based on that information • Or refer the loan application for further review and analysis by a loan underwriter
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Chapter 3: The Mortgage Lending Process
Desktop Underwriter® (DU®)and Loan Prospector®
• DU® is Fannie Mae’s Automated Underwriting System – The electronic system puts lenders in direct contact with Fannie Mae – Provides streamlined process of document submission, underwriting, and loan approval
• Loan Prospector® is Freddie Mac’s direct electronic underwriting system
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Chapter 3: The Mortgage Lending Process
The DU® • Looks at 14 separate factors about the borrower and the property • According to Fannie Mae, the 3 most important factors it considers are: 1. Equity in the property 2. Credit history of the borrower (including credit score) 3. Liquid reserves the borrower has in the bank Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
The Art of Qualifying a Borrower
• Qualifying a borrower simply means evaluating a borrower's creditworthiness • Borrower is evaluated to make sure he meets minimum qualifying standards • Property is evaluated • Evaluation process is loan underwriting, where an underwriter evaluates various risk factors associated with the loan
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Chapter 3: The Mortgage Lending Process
The Art of Qualifying a Borrower
• Primary concern: Determining degree of risk a loan represents • Underwriter’s fundamental questions: 1. Is there sufficient value in the property pledged as collateral to assure recovery of the loan amount in the event of default? 2. Does the borrower’s overall financial situation, comprised of income, credit history, and net worth, indicate he or she can reasonably be expected to make the proposed monthly loan payments in a timely manner?
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Chapter 3: The Mortgage Lending Process
The Art of Qualifying a Borrower
• When qualifying a borrower for a conventional loan use Fannie Mae and Freddie Mac underwriting criteria • The most important information reviewed when qualifying a borrower for a particular loan is: − Income − Credit history − Net worth Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Income Qualifying Standards
• When considering a borrower's income, there are two important income factors that lenders look at: 1. Housing expense ratio 2. Total debt service ratio • Borrowers must qualify under both ratios
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Chapter 3: The Mortgage Lending Process
Housing Expense Ratio • A borrower's housing expense ratio is the relationship of the borrower's total monthly housing expense to income, expressed as a percentage
Total Housing Expense ÷ Income = Ratio %
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Chapter 3: The Mortgage Lending Process
Housing Expense Ratio • Conventional lenders consider a borrower’s income adequate if the proposed total mortgage payment of principal, interest, taxes and insurance (PITI) does not exceed 28% of stable monthly income • Stable monthly income is income that can reasonably be expected to continue in the future
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Chapter 3: The Mortgage Lending Process
Total Debt Service Ratio • A borrower's total debt service ratio is the relationship of the borrower's total monthly debt obligations (including housing and longterm debts with more than ten payments left) to income, expressed as a percentage
Total Debt Service ÷ Income = Ratio %
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Chapter 3: The Mortgage Lending Process
Total Debt Service Ratio • Conventional lenders: Not to exceed 36% of stable monthly income • Alimony, child support, or any other courtordered obligations must count as debt against this ratio. • Debts with less than ten payments may still be counted against the borrower if payments are high • Student loans currently in deferment will need to be calculated into the expenses Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Using Ratios to Determine Maximum Mortgage Payment • Determine the maximum mortgage payment under the 1st ratio: − Multiply borrower’s stable monthly income by the maximum housing expense ratio (28% or 0.28)
• Determine the maximum mortgage payment under the 2nd ratio: − Multiply the borrower’s stable monthly income by the maximum total debt service ratio (36% or 0.36) − This gives you the amount of total long-term debts the borrower is permitted to have Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Using Ratios to Determine Maximum Mortgage Payment • Take this 2nd total amount and subtract the monthly long-term obligations the borrower already has (not including mortgage payments) • This gives you a figure that represents the largest mortgage payment allowed under the second ratio • Since borrower must qualify under both ratios, smaller of the 2 is the maximum allowable mortgage payment
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Chapter 3: The Mortgage Lending Process
Stable Monthly Income • Monthly income that can reasonably be expected to continue in the future • All income sources may be counted, however the lender must do a thorough analysis • Underwriters study the quality (dependability) and durability (probability of continuance) of income
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Chapter 3: The Mortgage Lending Process
Stable Monthly Income Sources
• Bonuses, commissions, • Rental income • Alimony, child support, and maintenance and part-time earnings • Overtime • Self-employment income • Disability payments • Co-mortgagor • Social Security •Unemployment and • Pensions and retirement welfare (if verifiable, benefits continuous, and ongoing) • Interest-yielding investments Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Evaluating Income When deciding which income will count toward a home purchase and deciding its strength, the lender takes each income source and looks at: • Employment history • Advancement • Education/training
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Chapter 3: The Mortgage Lending Process
Employment History • Underwriter will also analyze the individual’s employment stability • Borrowers with a history of steady, full-time employment receive more favorable consideration than those who change employers frequently • Unless the changes are properly explained
• General rule: Borrower should have continuous employment for at least two years in the same field Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Advancement • Favorably viewed by underwriter: − If the borrower has changed employers for the sake of advancement within the same line of work • Unfavorably viewed by underwriter: − Persistent job-hopping without advancement usually signifies a problem–individual’s earnings may be regarded as unstable
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Chapter 3: The Mortgage Lending Process
Education and Training • Special education or training that prepares a person for a specific kind of work can strengthen a loan application • Can offset minor weaknesses with respect to earnings or job tenure, especially if the underwriter is convinced there's: − A continuing demand for people in this line of work − Job stability in that particular field − Opportunity for advancement Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Computing Monthly Income
• After deciding which income will count, all gross monthly income from those sources is added together to arrive at a total gross monthly income figure • If a borrower earns an hourly wage, it must be converted to a monthly figure: • Multiply the hourly wage by 40 (hours in a work week) • Multiply by 52 (weeks in a year) • Divide by 12 (months in a year)
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Chapter 3: The Mortgage Lending Process
Verifying Income • The borrower can substantiate employment/income by providing: – W-2 forms for the previous 2 years – Original payroll stubs for the previous 30-day period • Verbal employment confirmations are normally done on each borrower prior to closing • Verification of Employment forms may be used
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Chapter 3: The Mortgage Lending Process
Credit History • Record of debt repayment • How a person paid credit accounts in the past as a guide to whether he is likely to pay accounts on time and as agreed in the future
• Debts: Any recurring monetary obligation that cannot be canceled • Credit scoring: An objective means of determining the creditworthiness of potential borrowers based on a number system • Credit score: A numeric representation of the borrower's credit profile Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Credit History • Underwrite analyzes borrower’s (and co-borrowers) credit history by obtaining a credit report from a national credit bureau • Slow payment record or other derogatory credit information could cause loan application to be denied or put the borrower into a high-risk category • In some cases, these issues don’t prevent a borrower from obtaining a loan if the credit problems can be explained.
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Chapter 3: The Mortgage Lending Process
Credit Scoring • An objective means of determining creditworthiness of potential borrowers based on a number system • The numbers adjust up and down based on strengths and weaknesses of particular qualification • Play important role in automated underwriting
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Chapter 3: The Mortgage Lending Process
FICO/BEACON Scores These scores (which range from about 300 – 850) consider: Number of open accounts • Presence of adverse public records Total credit limit • # of recent credit Types of credit Length of credit history inquiries • Re-establishment of Total amount of debt positive credit history outstanding • # of late payments in the after past payment past 30-60-90 days problems • • • • •
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Chapter 3: The Mortgage Lending Process
Secondary Market • Applies pricing adjustments to the interest rate depending upon FICO score and LTV • Fannie Mae and Freddie Mac guidelines: – Above 720 acceptable credit risk – 620 – 660 marginal credit risk (comprehensive review) – Below 620 will not accept loans for certain products and programs Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Explaining Derogatory Credit • If a few derogatory items appear on credit report, explanations for their occurrence can be explained, and showing prior and subsequent good credit ratings can help • The Notice to the Home Loan Applicant Credit Score Information Disclosure, as mandated by the Fair and Accurate Transactions Act, must be provided to borrowers
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Chapter 3: The Mortgage Lending Process
Bankruptcy • As established by federal law, it is a court process that cancels debt and provides some relief for creditors • There are 2 basic proceedings: 1. Chapter 7 Bankruptcy − Liquidation proceeding
1. Chapter 13 Bankruptcy − Allows debtor to pay off debt over time
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Bill Consolidation and Refinancing
• Even without derogatory ratings, lenders may find other concerns that indicate the borrower is a marginal credit risk • Subjective consideration is likely to influence the lender’s decision if a borrower is weak in other areas (e.g., income or net worth)
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Chapter 3: The Mortgage Lending Process
Verifying Credit History • Lenders will accept only credit reports they obtain directly from credit reporting agencies • Borrowers must give written authorization to obtain a credit report (verbal authorization must be documented in loan log) • Consumers may request one free credit report per year from each of the national credit bureaus ( www.annualcreditreport.com) if: – Information in a credit report resulted in some sort of adverse action – Victim of ID theft and fraud alert inserted – File has inaccurate information because of fraud – Consumer is on public assistance or unemployed Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Net Worth • Determined by subtracting liabilities from total assets − The value of all property (real and personal) a person has accumulated after subtracting all debts or obligations owed • Fannie Mae says that, “accumulation of net worth is a strong indication of credit worthiness” • A marginal total debt service ratio can be offset with an above average net worth
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Chapter 3: The Mortgage Lending Process
Evaluating Net Worth 1. Confirmation the borrower has sufficient assets and personal money to make the down payment and pay closing costs 2. Confirmation that the borrower has adequate reserves to cover two months of PITI mortgage payments after making a down payment and paying closing costs. 3. Confirmation the borrower has other assets, showing an ability to manage money and a resource, if needed, to handle emergencies and make mortgage payments Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Down Payment Borrower must have sufficient liquid assets to make the cash down payment and pay closing costs and other expenses incidental to the property purchase: • Liquid assets • Two months of bank statements • Verification of Deposit form
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Reserves • Cash on deposit or other highly liquid assets a borrower has available • Lenders would like to see enough to cover 2 months’ PITI mortgage payments (after down payment and closing costs are paid) − 6 months’ for investment properties
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Other Assets • Real estate equity – The difference between the market value of the property and the sum of the mortgages and other liens against the property
• Equity in automobiles, furniture, jewelry, stocks, bonds, and cash value life insurance policies
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Verifying Deposits for Down Payment/Reserves • 2 months’ bank statements and a Verification of Deposit form may be used • Questions considered by the underwriter: 1. Does the verified information conform to statements in the loan application? 2. Is there enough money in the bank to pay costs of buying the property? 3. Has the bank account been opened recently (within the last few months)? 4. Is the present balance notably higher than the average balance?
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Chapter 3: The Mortgage Lending Process
Gift Letter • A letter signed by the donor of the monetary gift • Should clearly state the money does not have to be repaid • Usually must be from an immediate family member, though rules can vary • Must verify the donor has the funds available with a copy of the gift check and a copy of the deposit receipt
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Verifying Assets • A section devoted to assets is included in every loan application • Underwriter takes necessary steps to verify the nature and value of assets held by a borrower • Purpose: Ensure the borrower has sufficient assets or reserves to handle typical household emergencies Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Closing the Loan • Closing is the transfer of ownership of real property from seller to buyer, according to the terms and conditions in the sales contract or escrow agreement • This is the final stage in a real estate transaction, when seller receives value for property (cash, mortgage, etc.) and buyer gets title
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Closing Procedures • Two types of closings: 1. Escrow closings conducted by a disinterested third party 2. Roundtable closings conducted with all parties present
• In both cases, the mechanics of closing are normally the responsibility of an escrow or settlement agent or attorney
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Closing Procedures • Escrow agent may be lender’s in-house escrow dept., an independent escrow company, or a title insurance company • Escrow agent follows the instructions of both buyer and seller • A copy of the sales contract or escrow instructions must be provided to the escrow agent, the title company, and the lender • Escrow agent gathers all necessary documents, making sure they're properly signed Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Closing Procedures • If there are no unforeseen problems during closing, loan papers are signed and there's one final check to be sure everything is in order • Escrow agent calculates the various prorations, adjustments, and fees charged to each party • Loan funds are disbursed to the proper parties according to the sales contract or escrow instructions • Each party is given a settlement statement that complies with RESPA Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Settlement Reconciliation • Debits: Sums of money owed • Credits: Sums of money received – Debits owed by the buyer are totaled and added to the purchase price – Credits are totaled and subtracted from the total debits to determine how much money the buyer must bring to closing – Similar process occurs on the seller’s side
• Acquisition cost: Total of the amount of money necessary to purchase the property
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Proration • Division of expenses between buyer and seller in proportion to the actual usage of the item represented by a particular expense as of the day the loan is funded – Accrued expenses: the cost has been incurred, but the expense has not yet been paid – Prepaid expenses: Items on a settlement statement the seller has already paid
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Proration • Expenses may be prorated using: – 360-day year (12 months of 30 days each) – 365-day year (counting the exact number of days in each month, leap years accounted for)
• Often, local custom dictates which factor is used • Either way, the steps to calculate the adjustment are similar
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Calculating Proration • Determine if the expense is accrued or prepaid • Divide the expense by the appropriate period to find a monthly (daily) rate • Determine how many months (days) are affected by the expense • Multiply the monthly (daily) rate by the number of affected months (days) • Determine which party is credited and which is debited Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Exercise 3-1 Sam Able wants to buy a home, and it’s estimated that an 80% conventional loan will have a mortgage payment of $878. He has an automobile payment of $212 a month with 14 installments remaining. He earns $700 per week. His down payment and closing costs are estimated at $18,400. Sam is selling a home with equity of $14,000. He has a checking and savings account with a local bank, and plans to draw on that account to close the transaction. The Verification of Deposit came back showing that Sam’s savings account has an average monthly balance of $1,000 and a current balance of $3,600. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Exercise 3-1 1. What is Sam’s housing expense ratio? $700 weekly income x 52 weeks = $36,400 annual income $36,400 annual income ÷ 12 months = $3,033.33 monthly income $878 mortgage payment ÷ $3,033.33 monthly income = 0.29
(29% housing expense ratio)
2. What is Sam’s total debt service ratio? $878 mtg payment + $212 auto pymt = $1,090 total debt service $1,090 total debt service ÷ $3,033.33 monthly income = 0.36
(36% total debt service ratio)
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Exercise 3-1 3. Will Sam have any problems closing this transaction? Explain. Yes, Mr. Able will have a few problems closing this transaction. The equity in his home ($14,000) plus money in the bank ($3,600) equals only $17,600, but his down payment plus estimated closing costs = $18,400. He needs to show two additional months of cash reserves, and his housing expense ratio of 29% exceeds guidelines. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Exercise 3-1 4. Do you see any problems with Sam’s Verification of Deposit? Explain. Yes, Mr. Able’s Verification of Deposit is a problem because his current balance of $3,600 is significantly higher than his average balance of $1,000. He will need to have a good explanation of where the funds came from so the lender knows that he did not borrow the down payment. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Exercise 3-2 Two months ago, Lisa Zorn was honorably discharged from the Air Force, where she spent four years training as an airplane mechanic. After discharge, she moved to take an apprentice mechanic job with a major airline company where she earns $18/hour. Last month, her husband Dave found a job with a local hospital as a nurse making $625 per week. They just bought a new car and pay $400 each month on that loan.
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Exercise 3-2 1.
What is the maximum housing expense a lender would allow?
$18 hrly wage x 40 hrs in a wk x 52 wks = $37,440 annual income $37,440 annual income ÷ 12 months = $3,120 Mrs. Zorn’s monthly income $625 weekly income x 52 weeks = $32,500 annual income $32,500 annual income ÷ 12 months = $2,708.33 Mr. Zorn’s monthly income
$3,120 + $2,708.33 = $5,828.33 total stable monthly income $5,828.33 x 0.28 = $1,631.93
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maximum housing expense
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Exercise 3-2 2. What is the maximum total debt service a lender would allow? $5,828.33 x 0.36 = $2,098.20 maximum debt service allowed $2,098.20 - $400 (car loan) = $1,698.20 max. housing expenses allowed
Remember: Use the lower monthly payment allowable, which is $1,631.93.
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Exercise 3-2 3. Can the Zorns get approved for a loan even though they’ve only been at their jobs a short time? Explain. Yes, although Lisa and Dave have only been at their jobs a short time, Lisa had special training in the Air Force, and Dave is a vocational nurse, which also implies special training. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Summary 1.
The common areas of work for a mortgage professional are loan originator, loan processor, underwriter, and servicer. A loan originator takes applications, pulls credit reports, orders appraisals, and assembles documents for mortgage loans. A loan processor works on the file assembled by the originator, verifying the information in the file and coordinating other aspects of the loan and closing. The underwriter is responsible for reviewing the file and arriving at a credit decision for the lender or investor, based on the credit risk associated with a particular loan. If there are conditions on the loan, they must be satisfied prior to closing. A servicer oversees the collection of mortgage payments and pursues late payments on behalf of the mortgagee.
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Summary 2. Borrowers can get pre-qualified or preapproved. Pre-qualification is when a real estate agent or lender reviews a borrower’s history to determine if they’re likely to get approved for a loan, and for about how much. Pre-qualification is not binding on the lender. Pre-approval is when a lender determines that potential borrowers can be financed for a certain amount. Mortgage brokers and real estate agents cannot give a buyer a preapproval, only a lender can. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Summary 3.
The loan process consists of four steps: 1. Consulting with a lender; 2. Completing the application; 3. Processing the application; 4. Analyzing the borrower and the property. Common fees include credit report, appraisal, title work, inspections, etc. A lender may require an application fee and/or require a deposit, or get costs from closing. The loan application asks a number of personal and financial questions, along with information about the property the borrower wishes to purchase. Address and employment information must go back two to three years. Income doesn’t have to include alimony/child support. Those who are selfemployed may need personal and company tax returns and financial statements. Assets and liabilities must all be disclosed, including alimony and child support, if it’s an obligation. Net worth is assets minus liabilities. Borrowers must answer declarations truthfully (e.g., “Is it part of down payment borrowed?” “Will the buyer use the home as the primary residence?”).
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Summary 4. The borrower and property are analyzed, and all information is verified. The underwriting process looks at: Capacity (ability to pay), collateral (down payment, home value), credit (good payment history), character (job stability, reserves), and conditions (health of job market, economy). Automated underwriting is a computerized look at the first three Cs, and it can recommend accepting the loan, or refer it to a human for consideration.
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Summary 5.
Some elements of the mortgage process are automated to reduce time and costs for lenders. Fannie Mae’s automated underwriting system is Desktop Underwriter® (DU®), which puts lenders in direct contact with Fannie Mae, providing streamlined document submission, underwriting, and loan approval. (Freddie Mac’s system is called Loan Prospector®.) The three most important underwriting factors DU considers are equity in the property, credit history, and liquid reserves. Equity is the appraised value of a property, minus the loan amount still owed.
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Summary 6.
Fannie Mae and Freddie Mac look at monthly income stability, quality, and durability. Bonuses, commission, part-time earnings, and overtime all count if shown to be a consistent part of the borrower’s income for the past few years. Lenders will not usually count unemployment, welfare, and temporary income. Credit history is a record of debt repayment. Debt is any recurring money obligation that cannot be cancelled. Credit scoring is an objective means of evaluating credit. Lenders will verify assets and may require financial statements. A gift letter can show part of the down payment/closing costs are a non-repayable gift from relative.
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Summary 7.
Conforming loans sold on the secondary market (e.g., Fannie Mae and Freddie Mac) require income ratios of 28% for housing expense and 36% for debt service. The housing expense ratio is the relationship of the borrower’s total monthly housing expense (Principal, Interest, Taxes, Insurance or PITI) to income (stable monthly income), expressed as a percentage. Total debt service ratio is the relationship of the borrower’s total monthly debt obligations (including housing and long-term debts with more than ten payments remaining) to income (stable monthly income), expressed as a percentage. A borrower must qualify under both ratios.
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Summary 8. Closing is the transfer of ownership of real estate from a seller to a buyer, per terms and conditions in the sales contract or escrow agreement. Seller receives value for property (cash, mortgage, etc.) and buyer gets title. Closings can be escrow (done by a disinterested third party) or roundtable (conducted with all parties present), and must comply with RESPA.
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Quiz 1. A senior citizen cannot be discriminated against during the loan application process due to a. b. c. d.
Equal Credit Opportunity Act. Fair Housing Act. Real Estate Settlement Procedures Act. Regulation Z.
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Quiz 2. A borrower must provide employment information including a. one year of prior employment. b. two or three years of prior employment. c. two previous employers, regardless of length of employment. d. three previous employers, regardless of length of employment.
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Quiz 3. If the borrower is self-employed, he or she should provide a. average monthly income amount earned over the previous two years. b. employment verification from the last employer. c. profit and loss statements for the previous six years. d. tax returns for the previous two or three years.
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Quiz 4. A gift letter a. can come from a borrower’s parent or guardian only. b. cannot be used for part of the down payment. c. must be signed by the donor. d. must state when the gift is to be repaid.
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Quiz 5. The escrow agent may be from a(n) a. b. c. d.
independent escrow company. in-house escrow department. title insurance company. any of the above.
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Quiz 6. Conforming loans follow guidelines of a. b. c. d.
ECOA. Fannie Mae and Freddie Mac. the FHA. RESPA.
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Quiz 7. When qualifying for a conventional loan, stable monthly income can include a. alimony received (that a borrower chooses to reveal). b. Christmas bonuses received for the first time last year. c. erratic unemployment earnings. d. income from other family members. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Quiz 8. What can be used to offset a marginal or high total debt service ratio? a. b. c. d.
any co-mortgagor average credit score below-normal net worth solid co-mortgagor
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Quiz 9. The borrower’s age can a. be a legitimate reason for turning down a borrower under age 18. b. be a legitimate reason for turning down a borrower over age 65. c. always be considered in the loan underwriting process. d. never be considered in the loan underwriting process. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Quiz 10. A borrower has a stable monthly income of $3,200 and recurring monthly debts of $370. What is the maximum mortgage amount (PITI) he could get for a conforming loan? a. b. c. d.
$782 $896 $928 $1,152
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Chapter 3: The Mortgage Lending Process
Overview Chapter 3 discusses: • Roles of the mortgage professional • Pre-qualification and pre-approval and important differences between the two • The loan process • Standards relating to income, credit history, and net worth • Housing expense ratios and total debt service ratios using secondary market guidelines
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Key Terms • • • • •
Assets Credit History Credit Scoring Debts FICO Score
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• Housing Expense Ratio • Liabilities • Loan Originator • Loan Processor • Loan-to-Value Ratio (LTV) 3
Chapter 3: The Mortgage Lending Process
Key Terms • • • • •
PITI Point Pre-Approval Pre-Qualification Reserves
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• Servicer • Stable Monthly Income • Total Debt Service Ratio • Underwriter
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Chapter 3: The Mortgage Lending Process
The Role of the Mortgage Professional • Work for any bank, credit union mortgage lender, mortgage investor, or mortgage broker • Duties vary depending upon the size of the company • Important to understand basics of mortgage lending and what the duties may be depending on the type of lender you work for Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Functions of Mortgage Professionals In addition to typical office duties and paperwork: • Origination • Underwriting • Servicing
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Functions of Mortgage Professionals • Originating: The process of making or initiating a new loan • The Processor: Typically responsible for verification of the information contained in the file (such as sending out employment verification forms), and also coordination of the various aspects of the loan (such as working with the title company) Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Functions of Mortgage Professionals • Underwriting: The process of evaluating and deciding whether to make a new loan • Servicing: The continued maintenance of a loan after the loan has closed • Many mortgage companies offer a combination of these services to their clients
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Getting a Buyer Approved—In the Past
People completed loan applications only when ready to buy a particular home • Why loan applications ask for detailed information about prospective buyers so lenders can make informed decisions about whether to grant credit
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Getting a Buyer Approved— Today
• Growing trend toward pre-approving buyers for loans • Pre-approval can be a useful negotiating tool • Pre-approval is NOT the same as pre-qualifying buyers −The two terms are not interchangeable
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Pre-qualification • Process of pre-determining how much of a loan a potential home buyer might be eligible to borrow • May be done by an agent or the lender • Does NOT guarantee approval • Not binding on the lender − Lender simply saying it looks favorable that the buyer will eventually get approved Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Pre-approval • Process by which a lender determines if potential borrowers can be financed through the lender, and for what amount of money • Borrower completes several steps of the loan process • Lender is stating the borrower’s situation has been checked-out • Provided all circumstances stay the same, willing to loan a person up to a certain amount of money • Powerful negotiating tool
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Loan Approval Process The real estate loan approval process can be broken down into four steps: 1. 2. 3. 4.
Consulting with the lender Completing a loan application Processing a loan application Analyzing the borrower and property
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Consulting with the Lender
• Do not interject your own opinion into the situation • Always let clients or customers have the final say as to how they apply for a loan and with whom • If you represent more than one company program, always consult with your mortgage broker or employer regarding policies in all areas before giving any type of advice or recommendation
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Common Fees Associated with Real Estate Loans
• Application fee • Pulling buyer’s credit bureau report • Securing a property appraisal report • Preliminary title report • Completing inspections − If loan closes, title insurance, recording fees, and origination fee (aka loan service fee)
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Completing the Loan Application
• The loan application is the form lenders require potential borrowers to complete, listing all pertinent information about the borrower and property • The same application is often used for pre-approvals, with the same information being asked about the borrower, since the lender anticipates a pre-approval will eventually lead to a loan
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Data Needed for Application Will vary by lender, but usually includes: • Sales contract for home borrower wants to buy • Two years of residence history • Two years employment history • Income Information Continued on next slide
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Data Needed for Application • • • •
List of assets List of liabilities Copy of gift letter, if applicable Certificate of Eligibility for VA loans and DD-214, if applicable • Sales information regarding present home • Any other info the buyer feels is relevant or is requested by the lender
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Loan Application • Borrower typically completes during the initial consultation with lender • Designed to elicit responses that detail borrower’s history, trends, and attitude as a means of trying to predict future loan repayment behavior
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Chapter 3: The Mortgage Lending Process
Parts of the Loan Application • Section I: Type of Mortgage and Terms of the Loan • Section II: Property Information & Purpose of the Loan • Section III: Borrower Information • Section IV: Employment Information • Section V: Monthly Income and Combined • Section VI: Assets and Liabilities Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Parts of the Loan Application • Section VII: Details of the Transaction • Section VIII: Declarations • Section IX: Acknowledgment, Agreement, and Borrower’s Signatures • Section X: Information for Government Monitoring Purposes
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Processing the Loan Application
Other pertinent information about the buyer:
• Check stubs or W-2 forms • Copies of bank statements and other original documents • Verification forms sent out to buyer’s employer, banks, other creditors, and any previous mortgage lender. • Credit report will be ordered and a preliminary title report prepared • An approved appraiser will be contacted to appraise the property Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Analyzing the Borrower and the Property
When reviewing a borrower’s loan application, the lender considers five main categories: 1. 2. 3. 4. 5.
Capacity Collateral Credit Character Conditions
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Analyzing the Borrower and the Property
The lender will also want to know the source of the buyer’s down payment: • Savings, sale of a prior home, or gifts are all acceptable sources • Buyer usually can't use borrowed funds or gifts for the first 5%
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Underwriting Process • Involves reviewing the information it contains and verifying items as necessary • When lender receives the credit report, verification forms, preliminary title report, and appraisal, a loan package is put together and given to an underwriter • The underwriter is usually the final decision maker on a borrower's loan application • Process can be automated or done by an individual who works for the lender Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Automated Underwriting • Information from a loan applicant is fed into a computer • An evaluation comes back within minutes advising the lender to: • Accept the loan applicant based on that information • Or refer the loan application for further review and analysis by a loan underwriter
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Desktop Underwriter® (DU®)and Loan Prospector®
• DU® is Fannie Mae’s Automated Underwriting System – The electronic system puts lenders in direct contact with Fannie Mae – Provides streamlined process of document submission, underwriting, and loan approval
• Loan Prospector® is Freddie Mac’s direct electronic underwriting system
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The DU® • Looks at 14 separate factors about the borrower and the property • According to Fannie Mae, the 3 most important factors it considers are: 1. Equity in the property 2. Credit history of the borrower (including credit score) 3. Liquid reserves the borrower has in the bank Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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The Art of Qualifying a Borrower
• Qualifying a borrower simply means evaluating a borrower's creditworthiness • Borrower is evaluated to make sure he meets minimum qualifying standards • Property is evaluated • Evaluation process is loan underwriting, where an underwriter evaluates various risk factors associated with the loan
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The Art of Qualifying a Borrower
• Primary concern: Determining degree of risk a loan represents • Underwriter’s fundamental questions: 1. Is there sufficient value in the property pledged as collateral to assure recovery of the loan amount in the event of default? 2. Does the borrower’s overall financial situation, comprised of income, credit history, and net worth, indicate he or she can reasonably be expected to make the proposed monthly loan payments in a timely manner?
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The Art of Qualifying a Borrower
• When qualifying a borrower for a conventional loan use Fannie Mae and Freddie Mac underwriting criteria • The most important information reviewed when qualifying a borrower for a particular loan is: − Income − Credit history − Net worth Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Income Qualifying Standards
• When considering a borrower's income, there are two important income factors that lenders look at: 1. Housing expense ratio 2. Total debt service ratio • Borrowers must qualify under both ratios
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Housing Expense Ratio • A borrower's housing expense ratio is the relationship of the borrower's total monthly housing expense to income, expressed as a percentage
Total Housing Expense ÷ Income = Ratio %
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Housing Expense Ratio • Conventional lenders consider a borrower’s income adequate if the proposed total mortgage payment of principal, interest, taxes and insurance (PITI) does not exceed 28% of stable monthly income • Stable monthly income is income that can reasonably be expected to continue in the future
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Total Debt Service Ratio • A borrower's total debt service ratio is the relationship of the borrower's total monthly debt obligations (including housing and longterm debts with more than ten payments left) to income, expressed as a percentage
Total Debt Service ÷ Income = Ratio %
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Total Debt Service Ratio • Conventional lenders: Not to exceed 36% of stable monthly income • Alimony, child support, or any other courtordered obligations must count as debt against this ratio. • Debts with less than ten payments may still be counted against the borrower if payments are high • Student loans currently in deferment will need to be calculated into the expenses Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Using Ratios to Determine Maximum Mortgage Payment • Determine the maximum mortgage payment under the 1st ratio: − Multiply borrower’s stable monthly income by the maximum housing expense ratio (28% or 0.28)
• Determine the maximum mortgage payment under the 2nd ratio: − Multiply the borrower’s stable monthly income by the maximum total debt service ratio (36% or 0.36) − This gives you the amount of total long-term debts the borrower is permitted to have Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Using Ratios to Determine Maximum Mortgage Payment • Take this 2nd total amount and subtract the monthly long-term obligations the borrower already has (not including mortgage payments) • This gives you a figure that represents the largest mortgage payment allowed under the second ratio • Since borrower must qualify under both ratios, smaller of the 2 is the maximum allowable mortgage payment
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Stable Monthly Income • Monthly income that can reasonably be expected to continue in the future • All income sources may be counted, however the lender must do a thorough analysis • Underwriters study the quality (dependability) and durability (probability of continuance) of income
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Stable Monthly Income Sources
• Bonuses, commissions, • Rental income • Alimony, child support, and maintenance and part-time earnings • Overtime • Self-employment income • Disability payments • Co-mortgagor • Social Security •Unemployment and • Pensions and retirement welfare (if verifiable, benefits continuous, and ongoing) • Interest-yielding investments Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Evaluating Income When deciding which income will count toward a home purchase and deciding its strength, the lender takes each income source and looks at: • Employment history • Advancement • Education/training
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Employment History • Underwriter will also analyze the individual’s employment stability • Borrowers with a history of steady, full-time employment receive more favorable consideration than those who change employers frequently • Unless the changes are properly explained
• General rule: Borrower should have continuous employment for at least two years in the same field Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Advancement • Favorably viewed by underwriter: − If the borrower has changed employers for the sake of advancement within the same line of work • Unfavorably viewed by underwriter: − Persistent job-hopping without advancement usually signifies a problem–individual’s earnings may be regarded as unstable
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Education and Training • Special education or training that prepares a person for a specific kind of work can strengthen a loan application • Can offset minor weaknesses with respect to earnings or job tenure, especially if the underwriter is convinced there's: − A continuing demand for people in this line of work − Job stability in that particular field − Opportunity for advancement Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Computing Monthly Income
• After deciding which income will count, all gross monthly income from those sources is added together to arrive at a total gross monthly income figure • If a borrower earns an hourly wage, it must be converted to a monthly figure: • Multiply the hourly wage by 40 (hours in a work week) • Multiply by 52 (weeks in a year) • Divide by 12 (months in a year)
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Verifying Income • The borrower can substantiate employment/income by providing: – W-2 forms for the previous 2 years – Original payroll stubs for the previous 30-day period • Verbal employment confirmations are normally done on each borrower prior to closing • Verification of Employment forms may be used
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Credit History • Record of debt repayment • How a person paid credit accounts in the past as a guide to whether he is likely to pay accounts on time and as agreed in the future
• Debts: Any recurring monetary obligation that cannot be canceled • Credit scoring: An objective means of determining the creditworthiness of potential borrowers based on a number system • Credit score: A numeric representation of the borrower's credit profile Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Credit History • Underwrite analyzes borrower’s (and co-borrowers) credit history by obtaining a credit report from a national credit bureau • Slow payment record or other derogatory credit information could cause loan application to be denied or put the borrower into a high-risk category • In some cases, these issues don’t prevent a borrower from obtaining a loan if the credit problems can be explained.
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Credit Scoring • An objective means of determining creditworthiness of potential borrowers based on a number system • The numbers adjust up and down based on strengths and weaknesses of particular qualification • Play important role in automated underwriting
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Chapter 3: The Mortgage Lending Process
FICO/BEACON Scores These scores (which range from about 300 – 850) consider: Number of open accounts • Presence of adverse public records Total credit limit • # of recent credit Types of credit Length of credit history inquiries • Re-establishment of Total amount of debt positive credit history outstanding • # of late payments in the after past payment past 30-60-90 days problems • • • • •
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Secondary Market • Applies pricing adjustments to the interest rate depending upon FICO score and LTV • Fannie Mae and Freddie Mac guidelines: – Above 720 acceptable credit risk – 620 – 660 marginal credit risk (comprehensive review) – Below 620 will not accept loans for certain products and programs Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Chapter 3: The Mortgage Lending Process
Explaining Derogatory Credit • If a few derogatory items appear on credit report, explanations for their occurrence can be explained, and showing prior and subsequent good credit ratings can help • The Notice to the Home Loan Applicant Credit Score Information Disclosure, as mandated by the Fair and Accurate Transactions Act, must be provided to borrowers
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Bankruptcy • As established by federal law, it is a court process that cancels debt and provides some relief for creditors • There are 2 basic proceedings: 1. Chapter 7 Bankruptcy − Liquidation proceeding
1. Chapter 13 Bankruptcy − Allows debtor to pay off debt over time
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Bill Consolidation and Refinancing
• Even without derogatory ratings, lenders may find other concerns that indicate the borrower is a marginal credit risk • Subjective consideration is likely to influence the lender’s decision if a borrower is weak in other areas (e.g., income or net worth)
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Verifying Credit History • Lenders will accept only credit reports they obtain directly from credit reporting agencies • Borrowers must give written authorization to obtain a credit report (verbal authorization must be documented in loan log) • Consumers may request one free credit report per year from each of the national credit bureaus ( www.annualcreditreport.com) if: – Information in a credit report resulted in some sort of adverse action – Victim of ID theft and fraud alert inserted – File has inaccurate information because of fraud – Consumer is on public assistance or unemployed Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Net Worth • Determined by subtracting liabilities from total assets − The value of all property (real and personal) a person has accumulated after subtracting all debts or obligations owed • Fannie Mae says that, “accumulation of net worth is a strong indication of credit worthiness” • A marginal total debt service ratio can be offset with an above average net worth
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Evaluating Net Worth 1. Confirmation the borrower has sufficient assets and personal money to make the down payment and pay closing costs 2. Confirmation that the borrower has adequate reserves to cover two months of PITI mortgage payments after making a down payment and paying closing costs. 3. Confirmation the borrower has other assets, showing an ability to manage money and a resource, if needed, to handle emergencies and make mortgage payments Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Down Payment Borrower must have sufficient liquid assets to make the cash down payment and pay closing costs and other expenses incidental to the property purchase: • Liquid assets • Two months of bank statements • Verification of Deposit form
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Reserves • Cash on deposit or other highly liquid assets a borrower has available • Lenders would like to see enough to cover 2 months’ PITI mortgage payments (after down payment and closing costs are paid) − 6 months’ for investment properties
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Other Assets • Real estate equity – The difference between the market value of the property and the sum of the mortgages and other liens against the property
• Equity in automobiles, furniture, jewelry, stocks, bonds, and cash value life insurance policies
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Verifying Deposits for Down Payment/Reserves • 2 months’ bank statements and a Verification of Deposit form may be used • Questions considered by the underwriter: 1. Does the verified information conform to statements in the loan application? 2. Is there enough money in the bank to pay costs of buying the property? 3. Has the bank account been opened recently (within the last few months)? 4. Is the present balance notably higher than the average balance?
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Gift Letter • A letter signed by the donor of the monetary gift • Should clearly state the money does not have to be repaid • Usually must be from an immediate family member, though rules can vary • Must verify the donor has the funds available with a copy of the gift check and a copy of the deposit receipt
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Verifying Assets • A section devoted to assets is included in every loan application • Underwriter takes necessary steps to verify the nature and value of assets held by a borrower • Purpose: Ensure the borrower has sufficient assets or reserves to handle typical household emergencies Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Closing the Loan • Closing is the transfer of ownership of real property from seller to buyer, according to the terms and conditions in the sales contract or escrow agreement • This is the final stage in a real estate transaction, when seller receives value for property (cash, mortgage, etc.) and buyer gets title
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Closing Procedures • Two types of closings: 1. Escrow closings conducted by a disinterested third party 2. Roundtable closings conducted with all parties present
• In both cases, the mechanics of closing are normally the responsibility of an escrow or settlement agent or attorney
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Closing Procedures • Escrow agent may be lender’s in-house escrow dept., an independent escrow company, or a title insurance company • Escrow agent follows the instructions of both buyer and seller • A copy of the sales contract or escrow instructions must be provided to the escrow agent, the title company, and the lender • Escrow agent gathers all necessary documents, making sure they're properly signed Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Closing Procedures • If there are no unforeseen problems during closing, loan papers are signed and there's one final check to be sure everything is in order • Escrow agent calculates the various prorations, adjustments, and fees charged to each party • Loan funds are disbursed to the proper parties according to the sales contract or escrow instructions • Each party is given a settlement statement that complies with RESPA Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Settlement Reconciliation • Debits: Sums of money owed • Credits: Sums of money received – Debits owed by the buyer are totaled and added to the purchase price – Credits are totaled and subtracted from the total debits to determine how much money the buyer must bring to closing – Similar process occurs on the seller’s side
• Acquisition cost: Total of the amount of money necessary to purchase the property
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Proration • Division of expenses between buyer and seller in proportion to the actual usage of the item represented by a particular expense as of the day the loan is funded – Accrued expenses: the cost has been incurred, but the expense has not yet been paid – Prepaid expenses: Items on a settlement statement the seller has already paid
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Proration • Expenses may be prorated using: – 360-day year (12 months of 30 days each) – 365-day year (counting the exact number of days in each month, leap years accounted for)
• Often, local custom dictates which factor is used • Either way, the steps to calculate the adjustment are similar
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Calculating Proration • Determine if the expense is accrued or prepaid • Divide the expense by the appropriate period to find a monthly (daily) rate • Determine how many months (days) are affected by the expense • Multiply the monthly (daily) rate by the number of affected months (days) • Determine which party is credited and which is debited Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Exercise 3-1 Sam Able wants to buy a home, and it’s estimated that an 80% conventional loan will have a mortgage payment of $878. He has an automobile payment of $212 a month with 14 installments remaining. He earns $700 per week. His down payment and closing costs are estimated at $18,400. Sam is selling a home with equity of $14,000. He has a checking and savings account with a local bank, and plans to draw on that account to close the transaction. The Verification of Deposit came back showing that Sam’s savings account has an average monthly balance of $1,000 and a current balance of $3,600. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Exercise 3-1 1. What is Sam’s housing expense ratio? $700 weekly income x 52 weeks = $36,400 annual income $36,400 annual income ÷ 12 months = $3,033.33 monthly income $878 mortgage payment ÷ $3,033.33 monthly income = 0.29
(29% housing expense ratio)
2. What is Sam’s total debt service ratio? $878 mtg payment + $212 auto pymt = $1,090 total debt service $1,090 total debt service ÷ $3,033.33 monthly income = 0.36
(36% total debt service ratio)
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Exercise 3-1 3. Will Sam have any problems closing this transaction? Explain. Yes, Mr. Able will have a few problems closing this transaction. The equity in his home ($14,000) plus money in the bank ($3,600) equals only $17,600, but his down payment plus estimated closing costs = $18,400. He needs to show two additional months of cash reserves, and his housing expense ratio of 29% exceeds guidelines. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Exercise 3-1 4. Do you see any problems with Sam’s Verification of Deposit? Explain. Yes, Mr. Able’s Verification of Deposit is a problem because his current balance of $3,600 is significantly higher than his average balance of $1,000. He will need to have a good explanation of where the funds came from so the lender knows that he did not borrow the down payment. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Exercise 3-2 Two months ago, Lisa Zorn was honorably discharged from the Air Force, where she spent four years training as an airplane mechanic. After discharge, she moved to take an apprentice mechanic job with a major airline company where she earns $18/hour. Last month, her husband Dave found a job with a local hospital as a nurse making $625 per week. They just bought a new car and pay $400 each month on that loan.
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Exercise 3-2 1.
What is the maximum housing expense a lender would allow?
$18 hrly wage x 40 hrs in a wk x 52 wks = $37,440 annual income $37,440 annual income ÷ 12 months = $3,120 Mrs. Zorn’s monthly income $625 weekly income x 52 weeks = $32,500 annual income $32,500 annual income ÷ 12 months = $2,708.33 Mr. Zorn’s monthly income
$3,120 + $2,708.33 = $5,828.33 total stable monthly income $5,828.33 x 0.28 = $1,631.93
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Exercise 3-2 2. What is the maximum total debt service a lender would allow? $5,828.33 x 0.36 = $2,098.20 maximum debt service allowed $2,098.20 - $400 (car loan) = $1,698.20 max. housing expenses allowed
Remember: Use the lower monthly payment allowable, which is $1,631.93.
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Exercise 3-2 3. Can the Zorns get approved for a loan even though they’ve only been at their jobs a short time? Explain. Yes, although Lisa and Dave have only been at their jobs a short time, Lisa had special training in the Air Force, and Dave is a vocational nurse, which also implies special training. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Summary 1.
The common areas of work for a mortgage professional are loan originator, loan processor, underwriter, and servicer. A loan originator takes applications, pulls credit reports, orders appraisals, and assembles documents for mortgage loans. A loan processor works on the file assembled by the originator, verifying the information in the file and coordinating other aspects of the loan and closing. The underwriter is responsible for reviewing the file and arriving at a credit decision for the lender or investor, based on the credit risk associated with a particular loan. If there are conditions on the loan, they must be satisfied prior to closing. A servicer oversees the collection of mortgage payments and pursues late payments on behalf of the mortgagee.
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Summary 2. Borrowers can get pre-qualified or preapproved. Pre-qualification is when a real estate agent or lender reviews a borrower’s history to determine if they’re likely to get approved for a loan, and for about how much. Pre-qualification is not binding on the lender. Pre-approval is when a lender determines that potential borrowers can be financed for a certain amount. Mortgage brokers and real estate agents cannot give a buyer a preapproval, only a lender can. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Summary 3.
The loan process consists of four steps: 1. Consulting with a lender; 2. Completing the application; 3. Processing the application; 4. Analyzing the borrower and the property. Common fees include credit report, appraisal, title work, inspections, etc. A lender may require an application fee and/or require a deposit, or get costs from closing. The loan application asks a number of personal and financial questions, along with information about the property the borrower wishes to purchase. Address and employment information must go back two to three years. Income doesn’t have to include alimony/child support. Those who are selfemployed may need personal and company tax returns and financial statements. Assets and liabilities must all be disclosed, including alimony and child support, if it’s an obligation. Net worth is assets minus liabilities. Borrowers must answer declarations truthfully (e.g., “Is it part of down payment borrowed?” “Will the buyer use the home as the primary residence?”).
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Summary 4. The borrower and property are analyzed, and all information is verified. The underwriting process looks at: Capacity (ability to pay), collateral (down payment, home value), credit (good payment history), character (job stability, reserves), and conditions (health of job market, economy). Automated underwriting is a computerized look at the first three Cs, and it can recommend accepting the loan, or refer it to a human for consideration.
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Summary 5.
Some elements of the mortgage process are automated to reduce time and costs for lenders. Fannie Mae’s automated underwriting system is Desktop Underwriter® (DU®), which puts lenders in direct contact with Fannie Mae, providing streamlined document submission, underwriting, and loan approval. (Freddie Mac’s system is called Loan Prospector®.) The three most important underwriting factors DU considers are equity in the property, credit history, and liquid reserves. Equity is the appraised value of a property, minus the loan amount still owed.
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Summary 6.
Fannie Mae and Freddie Mac look at monthly income stability, quality, and durability. Bonuses, commission, part-time earnings, and overtime all count if shown to be a consistent part of the borrower’s income for the past few years. Lenders will not usually count unemployment, welfare, and temporary income. Credit history is a record of debt repayment. Debt is any recurring money obligation that cannot be cancelled. Credit scoring is an objective means of evaluating credit. Lenders will verify assets and may require financial statements. A gift letter can show part of the down payment/closing costs are a non-repayable gift from relative.
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Summary 7.
Conforming loans sold on the secondary market (e.g., Fannie Mae and Freddie Mac) require income ratios of 28% for housing expense and 36% for debt service. The housing expense ratio is the relationship of the borrower’s total monthly housing expense (Principal, Interest, Taxes, Insurance or PITI) to income (stable monthly income), expressed as a percentage. Total debt service ratio is the relationship of the borrower’s total monthly debt obligations (including housing and long-term debts with more than ten payments remaining) to income (stable monthly income), expressed as a percentage. A borrower must qualify under both ratios.
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Summary 8. Closing is the transfer of ownership of real estate from a seller to a buyer, per terms and conditions in the sales contract or escrow agreement. Seller receives value for property (cash, mortgage, etc.) and buyer gets title. Closings can be escrow (done by a disinterested third party) or roundtable (conducted with all parties present), and must comply with RESPA.
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Quiz 1. A senior citizen cannot be discriminated against during the loan application process due to a. b. c. d.
Equal Credit Opportunity Act. Fair Housing Act. Real Estate Settlement Procedures Act. Regulation Z.
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Quiz 2. A borrower must provide employment information including a. one year of prior employment. b. two or three years of prior employment. c. two previous employers, regardless of length of employment. d. three previous employers, regardless of length of employment.
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Quiz 3. If the borrower is self-employed, he or she should provide a. average monthly income amount earned over the previous two years. b. employment verification from the last employer. c. profit and loss statements for the previous six years. d. tax returns for the previous two or three years.
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Quiz 4. A gift letter a. can come from a borrower’s parent or guardian only. b. cannot be used for part of the down payment. c. must be signed by the donor. d. must state when the gift is to be repaid.
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Quiz 5. The escrow agent may be from a(n) a. b. c. d.
independent escrow company. in-house escrow department. title insurance company. any of the above.
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Quiz 6. Conforming loans follow guidelines of a. b. c. d.
ECOA. Fannie Mae and Freddie Mac. the FHA. RESPA.
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Quiz 7. When qualifying for a conventional loan, stable monthly income can include a. alimony received (that a borrower chooses to reveal). b. Christmas bonuses received for the first time last year. c. erratic unemployment earnings. d. income from other family members. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Quiz 8. What can be used to offset a marginal or high total debt service ratio? a. b. c. d.
any co-mortgagor average credit score below-normal net worth solid co-mortgagor
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Quiz 9. The borrower’s age can a. be a legitimate reason for turning down a borrower under age 18. b. be a legitimate reason for turning down a borrower over age 65. c. always be considered in the loan underwriting process. d. never be considered in the loan underwriting process. Mortgage Lending P&P 3rd Edition/Updated Nov. 6, 2009
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Quiz 10. A borrower has a stable monthly income of $3,200 and recurring monthly debts of $370. What is the maximum mortgage amount (PITI) he could get for a conforming loan? a. b. c. d.
$782 $896 $928 $1,152
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