Chapter 12 Controlling Default Risk, Borrower Qualification, and Loan Underwriting

Chapter 12 Learning Objectives Understand the important borrower and property characteristics that are the focus of borrower qualification Understand the important borrower and property characteristics that are the focus of borrower qualification Understand the legal relationship between the lender and the borrower Understand the legal relationship between the lender and the borrower Understand how the lender controls default risk Understand how the lender controls default risk 12-1

Borrower Qualifications Mortgage Credit Analysis includes Mortgage Credit Analysis includes Determining Maximum Loan Amount Determining Maximum Loan Amount Estimating Closing Costs Estimating Closing Costs Analyzing Credit History Analyzing Credit History Calculating Income and Housing Expense Calculating Income and Housing Expense Assessing Ability to Repay Assessing Ability to Repay 12-2

Characteristics of the Property Value determined by appraisal Value determined by appraisal Appraisal is affected by physical characteristics, location, financing, etc. Appraisal is affected by physical characteristics, location, financing, etc. 12-3

Characteristics of the Borrower Type and Stability of Income Type and Stability of Income Other Debt and Living Expenses Other Debt and Living Expenses Prime Vs. Sub-prime Loans Prime Vs. Sub-prime Loans Risk-based Lending, A-F Ratings Risk-based Lending, A-F Ratings 12-4

Default Risk Ability-to-pay Theory Ability-to-pay Theory For Whatever Reason, Borrower Cannot Make the Payments For Whatever Reason, Borrower Cannot Make the Payments Equity Theory (Put Option) Equity Theory (Put Option) The Lower the Equity, the Greater the Likelihood That the Borrower Will “Put” the Property in Place of the Debt, i.e., Default on the Mortgage The Lower the Equity, the Greater the Likelihood That the Borrower Will “Put” the Property in Place of the Debt, i.e., Default on the Mortgage 12-5

Borrower Qualifying Ratios Loan-to-Value Ratio (LTV) Loan-to-Value Ratio (LTV) The Higher the LTV Ratio, the Higher the Default Risk The Higher the LTV Ratio, the Higher the Default Risk Payment-to-Income Ratio Payment-to-Income Ratio ConventionalFHA/VA ConventionalFHA/VA PITI 28% 29% PITI 28% 29% PITI+other 36% 41% PITI+other 36% 41% 12-6

Mortgage Contracts Mortgage - Defines the Debt and Creates the Lien Against the Property Mortgage - Defines the Debt and Creates the Lien Against the Property Promissory Note - Outlines the Provisions of the Loan Promissory Note - Outlines the Provisions of the Loan Recourse vs. Non-Recourse Recourse vs. Non-Recourse Interest and Payment Structure Interest and Payment Structure Pre-Payment Pre-Payment Default and Acceleration Default and Acceleration Due-on-Sale Clause Due-on-Sale Clause Amount of Loan Amount of Loan Assignment of Rents and Income Assignment of Rents and Income 12-7