Level 23: Mortgage Brokers - Chapter 1: Mortgage Origination
Credit Reports
A major component of loan processing is ordering and checking the borrower's credit reports. Not all creditors report to all three of the big national credit reporting agencies (Equifax, Experian, and TransUnion), so a single individual could have a different score from each agency. If the lender can pull all three reports, they will use the median number for their loan decision. If a person has reports from two of the agencies, the lower score will be used (sorry). 😕
Your Need to Know
Although a license holder is not directly involved in approving the buyer's loan, you'll still want to understand and be able to explain the loan approval process to your client. That way, you can answer your client's questions and look out for their interests. You and the lender should work together to make this experience as understandable and smooth as possible.
After Origination
As I've mentioned before, most mortgages are sold in the secondary market soon after they are created. I want to give you a little more detail on how this process works and who's making it happen. Let's break it down into four steps... Step 1: The mortgage loan originator creates the mortgages. (You'll learn all about the mortgage loan originator, or MLO, in the next chapter.) Step 2: MLOs sell the loans to an aggregator, which is a larger mortgage company. Aggregators are in contact with the secondary market (including Fannie Mae, Freddie Mac, and Wall Street firms). Step 3: Mortgage-backed securities are formed and sold to a securities dealer. Step 4: Mortgages reach their final destination with investors. The investors who buy the mortgages can be insurance companies, pension funds, banks, foreign governments, hedge funds, or government-sponsored entities (GSEs) like Fannie Mae and Freddie Mac.
Closing
Closing. You know it as the end of something, or maybe just that glorious day on the calendar when a real estate deal is completed. If we're talking mortgage processes (and we are), closing is the consummation of a real estate transaction when all the necessary contracts are signed and the lender disburses the funds of the mortgage loan. The physical meeting at which the paperwork is signed for the property transfer is also called the closing.
Prepared Buyers
If you're a buyer's agent, it's particularly important for you to make sure your buyers are as knowledgeable and prepared as possible before you start showing them properties. If a buyer can only borrow enough money to afford a $200,000 house and you're showing them $300,000 houses all afternoon, everyone's time is wasted. ⏱ When you first take on a new buyer client, make sure they connect with a lender and get pre-approved for a loan before you start picking out properties.* First-time buyers may not know about this step, or they may be poorly guessing their budget by looking at estimated monthly payments online. Loan details are highly personalized, so seeing an example of the terms for someone with excellent credit who is putting 20% down can be misleading for many buyers. *You can provide them with a list of lenders to choose from, but do not insist on them using a specific lender.
Pre-Approval
In the pre-approval process, the expected interest rate and a specific approval amount can be established, and in some cases, the borrower can even "lock in" a rate. When there is an agreement that allows the borrower to secure the interest rate on a mortgage for a designated time period, this is called a rate lock. But what is more certain to happen, if the investigation into the borrower's financial status comes up positive, is that a pre-approval letter will be generated by the lender, indicating the borrower's ability to obtain financing pending property approval. (Pre-qualification letters can also be generated, but they don't carry nearly the same weight, because they are subject to verification of the borrower's financial status.) Pre-approval is always a wise first step for buyers, and it's practically a necessity in hot real estate markets. If a seller has multiple offers on their house, a buyer has an edge on the competition if they have material proof (in the form of a lender's pre-approval letter) of their ability to close the deal. A sure deal is often more attractive than a great offer that could fall through.
Funding
Next comes funding. This should be your favorite step, Mustafa. It's when you get your commission! That's because this is the step when the money officially goes through. Funding happens when the lender provides the cash in the amount of the approved loan. The closing attorney closes the loan. Usually, the homebuyer doesn't get the keys until funding (not just closing) has occurred. 🔑 Some mortgage loans may also involve a lender rebate. A lender rebate is a credit given by the lender to the borrower that may be used to pay third party settlement charges or to fund the escrow account. It is generally paid for by borrowers in the form of a higher interest rate.
Loan Processing
Making real estate loans carries a certain amount of risk for lenders. For this reason, lenders must have a firm grasp of a borrower's financial qualifications. During loan processing, the lender collects information from the buyer that will help determine the loan type and amount they will qualify for. The person who is seeking the loan will need to complete and submit an application to kick off the loan processing. Lenders have to consider a borrower's income, credit, debt, source of funds, and net worth. They do this by creating a file for each interested borrower containing pertinent information about them and the property. They also verify that the information provided by the borrower is actually true. You can't be too careful when loans can be for hundreds of thousands of dollars. Still, no analysis of a borrower's creditworthiness, no matter how thorough, can be enough to ensure that a loan is completely free of risk. Lenders must also consider the value of the collateral to lessen the risk.
Pre-Qualification and Pre-Approval
Pre-qualification and pre-approval are not the same thing. Pre-qualification is the first step in the loan application process in which lenders give prospective borrowers a general estimate of the loan amount for which they may be approved. It's based on information reported by the borrower. The buyer supplies info about their financial situation to the lender, who then provides a general estimate. Pre-approval is the official process of a borrower being approved by a lender to borrow a specific amount at an interest rate within a small range. A mortgage application, credit report, and supporting financial documentation are required. The borrower's assets, income, debt, and credit history must be verified. Rental history is not considered.
The Life of a Mortgage
Pre-qualification and pre-approval pave the way for a new mortgage. The creation of a new mortgage is called origination. Mortgages can be originated by mortgage brokers, mortgage bankers, or correspondent lenders. There are many processes that take place during the creation and maintenance of a mortgage. These include processing, underwriting, closing, funding, and servicing. These actions take place in the same specific order each time.
Real Estate Financing
Some people are able to pay cash for a new home, but the reality is that most buyers need to borrow a lot of money in order to buy real estate. The methods of real estate finance are many and varied. Consumers in this country and in this day and age are extremely familiar with the credit system. Most of us have credit cards that allow us to purchase items immediately and pay for them later or over an extended period of time. Real estate financing is the same concept on a larger scale. 💳 The real estate finance industry is a big business. It includes commercial banks, mortgage companies, mortgage brokers, mortgage bankers, correspondent lenders*, credit unions, savings and loans, and more. *Similar to a mortgage banker, a correspondent lender offers loans using their own money at their own risk. The difference is that a correspondent lender generally works on a smaller scale than mortgage brokers and bankers. Real estate financing necessitates many different jobs. From qualifying the borrower and qualifying the property in the underwriting process to providing various types of financing and closing services, a great deal of skilled work must be done to get a single house sold. People who work in the finance field (or closely alongside it, like you) must know the effects of significant federal legislation and the nature of finance.
Pre-Application and Fee Agreement
There is another (optional) step that comes early in the mortgage process, when a borrower first meets with a mortgage broker. A pre-application and fee agreement is an optional form used by mortgage brokers to communicate fees and make required disclosures to the loan applicant(s). It promotes well-informed customers from an early stage in the loan application process.
Pre-Qualification
There is no official application or form that needs filling out in the pre-qualification process. In fact, it is not uncommon for the exchange of information to be gathered entirely over the phone. 📞 Additionally, there may not be any verification of the financial status information — the applicant may be taken at their word. For that reason, the pre-qualification decision is only as good as the information supplied by the borrower. The borrower reports on their own income, assets, and debts. A credit report won't be pulled until pre-approval. Because there is little effort or expense incurred by the lender to determine pre-qualification, it is not the norm for there to be any fees associated with this step of the loan approval process.
Loan Servicing
There is one last step in the life of a mortgage, and it usually lasts for waaaay longer than all the other steps combined. I'm talking about servicing, which is the collection of monthly payments, usually including payments on the principal, interest, taxes, and insurance (or PITI), along with the maintenance of records. The loan servicer is also responsible for sending the collected funds to the note holder and contacting the borrower about any delinquencies. Additionally, the loan servicer will provide the borrower an annual statement that details the activity of the escrow account, showing the account balance and payments for property taxes, homeowners insurance, and other escrowed items. Loan servicing is convenient for homeowners, because they can make a single monthly house payment rather than sending (and budgeting for) several different expenses. Payment reminders come by mail or email, usually including an update on their current loan balance. It's a lot of paperwork, which is why mortgage servicing is a huge business. Servicing costs about 0.25% to 0.50% of the loan balance, and that fee is passed on to the borrower (usually from the secondary-market investor). While we're on the subject, I'll mention that a net basis rate or wholesale rate means that a servicing fee has not been included.
Underwriting
Underwriting is the process of deciding the level of risk a lender would take on by offering a loan to a certain borrower for a specific property. It's a complex process that has been automated to some degree, but still requires the work of a specially trained professional, called an underwriter. This decision about risk is made using the borrower's loan application, documents within their file, and information about the property for which the mortgage is sought. The underwriter will consider the borrower's income, assets, debt, and credit score.
Mortgage Commitment
What's even more official than pre-approval? A mortgage commitment is a lender's approval of a specific loan for a specific property. It's during the final loan approval process that the lender evaluates the subject property and determines whether to grant a mortgage commitment. The lender only approves the loan if they are satisfied with the borrower AND the property.
Chapter 1 Key Terms
✏️ pre-qualification: the first step in the loan application process in which lenders give prospective borrowers a general estimate of the loan amount for which they may be approved; based on information reported by the borrower ✏️ pre-approval: official process of a borrower being approved by a lender to borrow a specific amount at an interest rate within a small range; a mortgage application, credit report, and supporting financial documentation are required ✏️ rate lock: an agreement between a lender and a borrower that allows the borrower to secure the interest rate on a mortgage for a designated time period ✏️ mortgage commitment: a lender's approval of a specific loan for a specific property ✏️ pre-application and fee agreement: an optional form used by mortgage brokers to communicate fees and make required disclosures to loan applicant(s) ✏️ underwriting: the process of deciding the level of risk a lender would take on by offering a loan to a certain borrower for a specific property ✏️ lender rebate: a credit given by the lender to the borrower that may be used to pay third party settlement charges or to fund the escrow account; generally paid for by borrowers in the form of a higher interest rate