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Washington Real Estate PracticesLesson 9: Loan Qualifying © 2013 Rockwell Publishing
Introduction Topics in this lesson:standards lenders use to evaluate loan applications what buyers should look for when choosing loan © 2013 Rockwell Publishing
Preapproval Preapproval: buyer submits loan application and information to lender, who analyzes credit reputation, income, and net worth. © 2013 Rockwell Publishing
Preapproval Preapproval letterIf buyer is approved, lender issues letter stating it will lend buyer up to certain amount (assuming property meets lender’s standards). Preapproval letter typically valid only for stated period. Preapproval streamlines closing process and makes buyers more attractive to sellers. © 2013 Rockwell Publishing
Preapproval Preapproval letterPotential drawback: preapproval letter lets seller know how much buyer could spend. Buyer can ask lender for preapproval letter for particular transaction, simply stating that buyer is approved for amount of offer. © 2013 Rockwell Publishing
Prequalifying vs. PreapprovalPrequalifying: much more informal process, though not very common anymore. Agent asks questions about income, assets, debts, and credit history to help determine what financing buyers would qualify for. Buyers can do this online themselves. © 2013 Rockwell Publishing
Summary Prequalifying and PreapprovalPrequalification © 2013 Rockwell Publishing
The Underwriting ProcessLoan underwriting: process lender uses to evaluate mortgage loan applicant and security property, to determine whether proposed loan is good risk. © 2013 Rockwell Publishing
The Underwriting Process Lender’s risksIn making mortgage loans, lender assumes two risks: that borrower will fail to repay loan as agreed if borrower does default, security property will be worth less than what borrower owes lender © 2013 Rockwell Publishing
The Underwriting Process Underwriting standardsLender evaluates property based on appraisal. Most lenders evaluate applicants using uniform underwriting standards established by Fannie Mae and Freddie Mac. Otherwise loan is nonconforming and lender might not be able to sell it on secondary market. © 2013 Rockwell Publishing
The Underwriting Process Underwriting standardsLenders use underwriting standards to weed out riskier loan applicants. If applicant doesn’t meet underwriting standards, lender won’t make loan. Underwriting standards applied to both applicant and property. © 2013 Rockwell Publishing
Underwriting Standards Automated underwritingAutomated underwriting: many aspects of underwriting now handled by computer. Fannie Mae, Freddie Mac, and large lenders each have own automated underwriting system (AUS). © 2013 Rockwell Publishing
Underwriting Standards Automated underwritingAUS analyzes loan application and credit report, and makes recommendation for or against approval. Generally, underwriter must review software’s recommendation. © 2013 Rockwell Publishing
The Underwriting Process Underwriting standardsUnderwriter evaluates information in loan application, credit report, and verification forms. Three categories: income net worth credit reputation © 2013 Rockwell Publishing
The Underwriting Process IncomeLender uses two-step process to evaluate loan applicant’s income: First, lender determines applicant’s stable monthly income. Then, lender decides if stable monthly income is sufficient to make proposed loan’s monthly payments. © 2013 Rockwell Publishing
Income Stable monthly incomeBefore lender can judge whether applicant’s income is sufficient, lender must look at income’s quality and durability. Stable monthly income requires certain level of quality and durability. © 2013 Rockwell Publishing
Stable Monthly Income QualityIncome quality refers to reliability or dependability of source. Reasonably reliable sources of income include established private employers and government agencies. The less dependable the source of the income, the lower the quality of the income. © 2013 Rockwell Publishing
Stable Monthly Income DurabilityTo be stable, income must also be durable—expected to continue for reasonable period of time. Examples of durable income include: wages from permanent employment permanent disability benefits interest on established investments © 2013 Rockwell Publishing
Stable Monthly Income DurabilityIn contrast, unemployment benefits aren’t considered durable because they aren’t expected to continue for a long period of time. © 2013 Rockwell Publishing
Stable Monthly Income Acceptable types of incomeLenders have general rules of thumb for determining what is and what is not stable monthly income. © 2013 Rockwell Publishing
Acceptable Income Permanent employmentPermanent employment is most common source of stable monthly income. Generally, loan applicant must have history of continuous, stable employment—typically at least two years in same field. © 2013 Rockwell Publishing
Acceptable Income Permanent employmentBut extenuating circumstances may warrant loan approval without two-year work history. Example: applicant recently finished college or just left armed services. Special education or training can make up for minor weaknesses in job history. © 2013 Rockwell Publishing
Acceptable Income Permanent employmentLenders look favorably upon applicant changing jobs to advance within same line of work. But changing jobs persistently without any advancement is viewed as a problem. © 2013 Rockwell Publishing
Acceptable Income Self-employmentSelf-employment income is considered less durable and less reliable than income from permanent job. Applicant who has been self-employed for short time must show employment history in same field and reasonable chance of success on her own. © 2013 Rockwell Publishing
Acceptable Income Other employment incomeSecondary employment income—bonuses, commissions, part-time earnings, etc.—may sometimes be included if established in applicant’s earnings history. Overtime pay is not considered stable income unless regular part of applicant’s earnings. © 2013 Rockwell Publishing
Acceptable Income Secondary sourcesIncome from pensions and social security is acceptable as stable monthly income. Alimony or spousal support is acceptable if payments are reliable. Applicant must give lender copy of court decree ordering payments. © 2013 Rockwell Publishing
Acceptable Income Secondary sourcesChild support is considered stable monthly income only if required by court decree, and proof is provided of regular payment. © 2013 Rockwell Publishing
Acceptable Income Secondary sourcesThe closer child is to age of majority (when payments will stop), the less likely lender will include child support. If child is over 15, lender probably won’t count child support. © 2013 Rockwell Publishing
Acceptable Income Secondary sourcesIncome from public assistance programs acceptable as long as payments are expected to continue for sufficient period of time. Payments from welfare or food stamps may be counted as stable monthly income, depending on prospects for continued eligibility. © 2013 Rockwell Publishing
Acceptable Income Secondary sourcesEqual Credit Opportunity Act prohibits lenders from discriminating against loan applicants because income is from public assistance. © 2013 Rockwell Publishing
Acceptable Income Investment incomeIncome from investments can be considered stable monthly income. Unless applicant must sell investment for downpayment or closing costs. © 2013 Rockwell Publishing
Acceptable Income Rental incomeIncome from loan applicant’s rental properties can count as stable monthly income. Applicant must prove rental payments are made regularly. Lender generally bases allowable amount on property’s past net income. © 2013 Rockwell Publishing
Acceptable Income Co-mortgagorsLender may be willing to use income of co-mortgagor in qualifying loan applicant. Co-mortgagor: signs mortgage and note along with primary borrower and has same legal obligation to pay off loan. © 2013 Rockwell Publishing
Acceptable Income Co-mortgagorsParents frequently act as co-mortgagors to help children purchase first home. Co-mortgagors help loan application only if their income is enough to support both their own mortgage payment and new mortgage payment. © 2013 Rockwell Publishing
Stable Monthly Income Unacceptable types of incomeTypes of income usually NOT acceptable to lender (either because not reliable or not durable): unemployment benefits earnings of family members other than spouse income from temporary employment (either part-time or full-time) unless steady work © 2013 Rockwell Publishing
Summary Stable Monthly IncomeAcceptable income Unacceptable income © 2013 Rockwell Publishing
Income Verifying incomeTwo main methods of verifying employment income: Lender sends income verification form directly to applicant’s employer, who fills it out and sends it back directly to lender. © 2013 Rockwell Publishing
Income Verifying incomeApplicant gives lender W-2 forms for previous two years and payroll stubs or vouchers for previous 30-day period. Lender confirms information in documents by calling employer. © 2013 Rockwell Publishing
Income Verifying incomeCommission income: verified with copies of applicant’s federal income tax returns for previous two years. Self-employment income: verified with audited financial statements and federal income tax returns for previous two years. © 2013 Rockwell Publishing
Income Verifying incomeAlimony or child support: verified with copy of court decree and proof that payments have actually been received. Rental income: verified with recent income tax returns; usually other documentation too, such as leases. © 2013 Rockwell Publishing
Income Calculating monthly incomeAfter verifying applicant’s income, next step is to calculate monthly income. © 2013 Rockwell Publishing
Income Calculating monthly incomeConvert hourly wages to monthly income by multiplying by If a buyer gets paid twice a month, multiply paycheck amount by two. If buyer gets paid every two weeks, multiply by 26 to get annual income. Then divide that by 12 to get monthly income. © 2013 Rockwell Publishing
Income Ratios Lender sets maximum income ratios to ensure mortgage and other monthly debt payments don’t eat up too much monthly income. Two types of income ratios: debt to income ratio and housing expense to income ratio. © 2013 Rockwell Publishing
Income Ratios Debt to income ratio: measures monthly mortgage payment plus other regular installment debt payments against monthly income. Housing expense to income ratio: measures monthly mortgage payment against monthly income. © 2013 Rockwell Publishing
Income Ratios Monthly mortgage payment includes principal, interest, taxes, and insurance (PITI). Income ratio is expressed as a percentage. Each type of loan program has its own maximum income ratios. © 2013 Rockwell Publishing
Summary Income AnalysisIncome verification Calculating monthly income Income ratios © 2013 Rockwell Publishing
The Underwriting Process Net worthLender calculates applicant’s net worth by subtracting liabilities from assets. © 2013 Rockwell Publishing
The Underwriting Process Financial management skillsLenders feel applicant with significant net worth probably has good financial management skills and is good credit risk. If applicant’s income is marginal, above-average net worth could help approval. © 2013 Rockwell Publishing
Net Worth Cash for closingLender also investigates net worth to ensure applicant has enough cash to complete purchase (downpayment, closing costs, and other incidental expenses). © 2013 Rockwell Publishing
Net Worth Reserves Buyers often required to have reserves left after downpayment and closing costs. Typically, reserves must be enough to cover two or three mortgage payments. Means buyer could likely handle short emergency without defaulting. © 2013 Rockwell Publishing
Net Worth Assets Loan applicant lists assets on loan application, and lender does whatever it can to verify information. Encourage buyers to include anything of financial value, such as real estate, cars, furniture, jewelry, stocks, bonds, or cash value in life insurance policy. © 2013 Rockwell Publishing
Assets Liquid assets Liquid assets generally more important to lender than non-liquid assets. Liquid assets: cash and any other assets that can be quickly converted to cash. © 2013 Rockwell Publishing
Assets Account verificationLender will need buyer’s bank name, account number, and balance. Lender sends “Request for Verification of Deposit” form directly to bank, who returns it directly to lender. Or applicant may submit original bank statements for previous three months to verify sufficient cash for closing. © 2013 Rockwell Publishing
Assets Account verificationLender looks at four issues when verifying deposits: Does verified information conform to loan application? Does applicant have enough money in bank for expenses of purchasing property? © 2013 Rockwell Publishing
Assets Account verificationHas bank account been opened only recently (within last couple of months)? Is present balance notably higher than average balance? © 2013 Rockwell Publishing
Assets Account verificationIf account was recently opened or has higher than normal balance, lender may become suspicious. Strong indications that loan applicant borrowed funds to pay downpayment and closing costs—generally not allowed. © 2013 Rockwell Publishing
Assets Real estate If buyer is selling one home to buy another, she can use net equity in current home as liquid asset. Net equity: difference between market value of property and sum of liens against property, plus selling expenses. © 2013 Rockwell Publishing
Assets Real estate To estimate net equity available, take current home’s appraised value (or sales price if it’s in escrow), subtract outstanding mortgage and other liens, and then subtract estimated selling costs. © 2013 Rockwell Publishing
Assets Real estate If equity in other property will be main source of cash used to buy new property, lender will probably require proof property has been sold and buyer has received proceeds. © 2013 Rockwell Publishing
Assets Real estate If property won’t sell in time for closing, lender may provide swing loan (or bridge loan), which provides cash for closing on new home. When old home sells, swing loan is paid off from sale proceeds. © 2013 Rockwell Publishing
Net Worth Liabilities Applicant also lists all liabilities, including credit card balances, charge accounts, student loans, car loans, and other debts. If applicant owns real estate, remaining principal balance on mortgage and amount of any other liens are considered liabilities. © 2013 Rockwell Publishing
Net Worth Gift funds If buyer has income to qualify for loan, but not enough cash for downpayment and closing, his family may be willing to help. Generally allowed, as long as money is gift and not loan. © 2013 Rockwell Publishing
Net Worth Gift funds Relative’s gift of money must be confirmed with “gift letter” signed by donor, stating money is gift and does not have to be repaid. Lenders often have specific forms for gift letters, and may require them to be used. © 2013 Rockwell Publishing
Summary Net Worth Net worth Assets Liabilities Gift funds© 2013 Rockwell Publishing
The Underwriting Process Credit reputationNext, lender analyzes loan applicant's credit reputation by obtaining credit report. Applicant ordinarily pays credit report fee. © 2013 Rockwell Publishing
The Underwriting Process Credit reputationReport covers debt and repayment history for preceding seven years (primarily credit cards and loans). Other bills usually aren’t listed unless they were turned over to collection agency. © 2013 Rockwell Publishing
Credit Reputation Derogatory informationIf credit report shows history of credit trouble, loan may be declined. Derogatory credit information includes: slow payments, debt consolidations, collections, repossessions, foreclosures or short sales, judgments, and bankruptcies. © 2013 Rockwell Publishing
Credit Reputation Derogatory informationSlow payments: buyer with chronic late payments may be seen as financially overextended or not taking debt seriously. Debt consolidation: pattern of periodic “bailouts” through refinancing and debt consolidation suggests applicant has tendency to live beyond his means. © 2013 Rockwell Publishing
Credit Reputation Derogatory informationCollections: if creditor turns bill over to collection agency, this appears on credit report for seven years. Repossession: if someone buys personal property on credit and fails to make payments, creditor may be able to repossess it. Appears on credit report for seven years. © 2013 Rockwell Publishing
Credit Reputation Derogatory informationForeclosure: real estate foreclosure stays on debtor’s credit report for seven years. Previous foreclosure viewed very seriously. Similar weight given to short sales, etc. Judgment: listed on credit report for seven years after it’s entered in public record. © 2013 Rockwell Publishing
Credit Reputation Derogatory informationBankruptcy: appears on debtor’s credit report for ten years, rather than seven. Three different types of bankruptcy: Chapter 7: total discharge of debts Chapter 11: reorganization of business Chapter 13: reorganization of personal finances © 2013 Rockwell Publishing
Credit Reputation Credit scoresCredit scores are designed to measure likelihood someone will default on loan. Most commonly used is FICO (also called Fair Isaac). FICO scores range around 300 to 850. Higher score (over 700) = relative creditworthiness. © 2013 Rockwell Publishing
Credit Scores How credit scores are usedIf applicant has good credit score, the underwriter typically won't investigate further. But mediocre credit score will prompt underwriter to look more closely at circumstances of credit problems. © 2013 Rockwell Publishing
Credit Scores How credit scores are usedIf credit score is mediocre, lender might approve loan but charge higher interest rate to make up for increased risk. Sometimes called subprime loan. © 2013 Rockwell Publishing
Credit Scores Maintaining a good scorePrevious two years are most important to applicant’s score. Other factors with negative impact on score: constantly carrying credit card balance near maximum amount applying for too much credit © 2013 Rockwell Publishing
Credit Scores Maintaining a good scoreSeveral credit inquiries made within certain period (ranging from14 to 45 days) are treated as single inquiry in calculating credit score. Loan applicant was probably comparison-shopping for mortgage or car loan. © 2013 Rockwell Publishing
Credit Reputation Obtaining credit informationBefore house-hunting, buyer should check credit report for any errors or discrepancies (doesn’t count as credit inquiry). Get report from all three major agencies—Equifax, Experian, and TransUnion. Specifically ask for credit scores. © 2013 Rockwell Publishing
Credit Reputation Obtaining credit informationIf buyer finds any errors, he should contact credit agencies. Federal Fair Credit Reporting Act requires agencies to investigate any complaints and correct errors. © 2013 Rockwell Publishing
Credit Reputation Explaining credit problemsIf report has a few derogatory items, see if: they occurred during specific period for valid reason, and credit report before and after is acceptable. If problems can be explained and lender believes circumstances were only temporary, loan might be approved. © 2013 Rockwell Publishing
Credit Reputation Explaining credit problemsBuyer shouldn’t blame problems on creditors. Lender won’t look favorably on buyer not taking responsibility for previous credit problems. Buyer should go to lender and explain situation honestly. © 2013 Rockwell Publishing
Credit Reputation Explaining credit problemsIf payments were late for several months because borrow was laid off, he should tell lender. Lender is likely to be sympathetic, especially if borrower can show he's now steadily employed and paying bills on time. © 2013 Rockwell Publishing
Subprime Lending Buyer who doesn’t qualify for loan under standard underwriting requirements might be able to get a subprime loan. Subprime mortgages: riskier loans made using more flexible underwriting standards. © 2013 Rockwell Publishing
Subprime Lending Subprime borrowers often have poor or limited credit histories. Or may be borrowers who: can’t meet standard income and asset documentation requirements have good credit but carry a lot of debt want to purchase nonstandard properties © 2013 Rockwell Publishing
Subprime Lending In exchange for the added risk, subprime lenders usually charge higher interest rates and fees. Subprime loans also more likely to have prepayment penalties, balloon payments, and negative amortization. © 2013 Rockwell Publishing
Subprime Lending Late 1990s and early 2000s boom in subprime lending led to many defaults. Mortgage foreclosure epidemic affected entire economy. Subprime mortgages now much less common. © 2013 Rockwell Publishing
Summary Credit ReputationCredit report Credit scores Subprime lending © 2013 Rockwell Publishing
Choosing a Loan Buyers should look at several lenders and types of loans offered by each lender. In addition to interest rates, other important criteria: loan’s overall cost (APR), lender’s lock-in policies, and lender’s competence. © 2013 Rockwell Publishing
Choosing a Loan Loan costsAlong with interest, borrower pays loan origination fee and possibly discount points. Loan origination fee: for administrative cost of processing loan—typically ranges from 1% to 3% of loan amount. Discount points: increase lender's upfront yield or profit—range from 1% to 6% of loan amount (one to six points). © 2013 Rockwell Publishing
Choosing a Loan Loan costsLenders quoting low interest rates usually charge more points to compensate. Variation in loan fees between lenders and between loans could make it difficult to accurately compare loan costs. © 2013 Rockwell Publishing
Loan Costs Truth in Lending ActTruth in Lending Act (TILA): federal law requiring lenders to disclose cost of loans in same manner, to enable borrowers to compare costs and shop around for best rate. Implemented through Federal Reserve's Regulation Z. © 2013 Rockwell Publishing
Loan Costs Truth in Lending ActTILA’s most important disclosure is loan's annual percentage rate (APR). APR takes into account interest, points paid by borrower, loan origination fee, and mortgage insurance or guaranty fees. To accurately compare cost of two loans, buyer should compare APRs. © 2013 Rockwell Publishing
Loan Costs Truth in Lending ActUnder TILA, lender must give loan applicant disclosure statement with good faith estimate of financing charges within three business days after receiving application. Disclosure statement typically provided when application is submitted. © 2013 Rockwell Publishing
Choosing a Loan Lock-insIf interest rate isn’t locked in, lender can change it at any time before closing. When lender quotes rate, buyer should ask if rate will be locked in, and for how long. © 2013 Rockwell Publishing
Choosing a Loan Lock-insUnless lender will let buyer take advantage of rates dropping, buyer shouldn’t lock in rate if market rates appear likely to fall. Lender usually charges fee (.25% of loan amount, for example) to lock in interest rate. Fee may be applied to buyer's closing costs if transaction closes. © 2013 Rockwell Publishing
Choosing a Loan Lender competenceCompetent lenders will ensure loan process goes smoothly and no costly errors are made. Easiest way to judge good lender: ask experienced agents for advice. © 2013 Rockwell Publishing
Choosing a Loan Other considerationsEncourage buyers to think about financial and home ownership plans in long-term fashion. Buyers must choose type of loan based on their unique financial circumstances and goals. © 2013 Rockwell Publishing
Other Considerations In addition to APR and overall loan costs, buyers should consider the following: How much money will be left in savings after closing? How much money will be left over after the monthly loan payment? How long does the buyer plan to stay in this home? © 2013 Rockwell Publishing
Other Considerations Buyer planning to stay in the home for a short time wants to minimize the short-term cost of the property. Buyer who wants to retire early may be concerned with building equity and paying off the loan quickly. © 2013 Rockwell Publishing
Other Considerations First-time buyers with limited buying power typically want to purchase the most expensive home they can afford. Other buyers may want to invest their money elsewhere. © 2013 Rockwell Publishing
Summary Choosing a LoanTruth in Lending Act Annual percentage rate Lock-ins Other considerations © 2013 Rockwell Publishing
Predatory Lending Predatory lending: mortgage practices used to take advantage of unsophisticated borrowers. Predatory lenders tend to target elderly or minority borrowers. Especially those with limited income or limited English skills. © 2013 Rockwell Publishing
Predatory Lending Predatory lending practicesPredatory steering: directing buyer toward a more expensive loan than the buyer could otherwise obtain. Fee packing: charging interest rates, points, or other fees that far exceed market rates and aren’t justified by service provided. © 2013 Rockwell Publishing
Predatory Lending Predatory lending practicesLoan flipping: eating into homeowner’s equity by charging fees on repeat refinances. Disregarding buyer’s ability to pay: making loan based only on property’s value, without considering whether buyer will be able to afford payments. © 2013 Rockwell Publishing
Predatory Lending Predatory lending practicesBalloon payment abuses: making low monthly payment loan that is either partially amortized or interest-only, without disclosing existence of large balloon payment. Fraud: misrepresenting or concealing unfavorable loan terms or excessive fees, or using other fraudulent means to get borrower to agree to loan. © 2013 Rockwell Publishing
Predatory Lending Mortgage Broker Practices ActMortgage Broker Practices Act (MBPA): Washington’s anti-predatory lending act regulates mortgage brokers © 2013 Rockwell Publishing
Predatory Lending Mortgage Broker Practices ActMBPA prohibits mortgage brokers from: defrauding or misleading borrowers, lenders, or third parties contracting with borrower to receive fees even when borrower doesn’t actually obtain loan © 2013 Rockwell Publishing
Predatory Lending Mortgage Broker Practices Actmisrepresenting available rates, points, or financing terms failing to make required disclosures to loan applicants and other parties bribing an appraiser © 2013 Rockwell Publishing
Predatory Lending Mortgage Broker Practices Actadvertising interest rate without disclosing APR failing to pay third-party service providers within 30 days of recording loan closing documents acting as mortgage broker in own transaction or transaction handled by licensee working for same real estate brokerage © 2013 Rockwell Publishing
Mortgage Broker Practices Act PenaltiesViolation of the MBPA is misdemeanor. Individual harmed by violation can bring civil suit against mortgage broker’s bond. © 2013 Rockwell Publishing
Mortgage Broker Practices Act PenaltiesViolation of MBPA is also violation of Consumer Protection Act (CPA). Individuals can bring actions under CPA for 3x actual damages (up to $25,000). © 2013 Rockwell Publishing
Summary Predatory LendingMortgage Broker Practices Act © 2013 Rockwell Publishing
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