RFINANCE8: Underwriting Residential Property
The cost approach is most reliable for properties that were:
built recently, since the appraiser can get access to the actual costs of the development and construction. It's also a good approach for special purpose buildings when data on income is not available or there are no comparable sales. The cost approach attempts to estimate either the property's replacement cost or reproduction cost.
Once the loan processor has reviewed all of the information provided with the application, in addition to all other information that was collected, he or she will decide either to approve or reject the loan application.
If the processor decides the loan application is not acceptable, he or she will list all the reasons for rejection, inform the borrower and close the file. Sometimes rather than reject the loan entirely, the lender will give the borrower a less than A-rated loan. If the loan officer determines that the borrower is an acceptable risk, the loan process will continue with the evaluation of the property. Note: If the lender denies a loan on the basis of a credit report, the lender must disclose in writing that the borrower is entitled to a statement of reason from any creditor who is responsible for the negative report.
Principles of Value:
Many factors can influence the value of property. Anticipation - The benefits a buyer expects to receive over the period of time he or she has the property influence the decision to purchase it. The value of the property can increase or decrease depending on whether the anticipated change is a benefit or a disadvantage. For example, a buyer hears that the property down the street may become a shopping mall. Is that a benefit or a disadvantage? It may depend on the buyer's viewpoint. Assemblage - When two adjacent pieces of property are joined together, the value of the one larger parcel may be greater than the value of the two separately. For example, two lots are valued at $25,000 each, but when combined for one use, they have a value of $60,000. The extra value created by merging the two parcels is called plottage value. Change - Both market conditions and a property's physical condition change constantly over time. These changes affect the benefits of the property. Using our shopping mall example again, is the construction of a mall a benefit or a detriment to the property's value? An appraiser needs to keep abreast of these types of changes. Conformity - This principle says that a property is at its highest value when it conforms with and fits into its surroundings. If a three-bedroom, one-bath home is in a neighborhood where all the homes have two bathrooms, it might be wise for the owner to consider installing a second bathroom. Competition - This principle holds that when several businesses of a similar type are close to one another, together they may make more money than they would have individually. For example, several fast food chain restaurants located on the same major street attract more buyers than one fast food restaurant would if it sat by itself. Contribution - This is what the market recognizes as the change in value an improvement makes to a property, rather than what that improvement actually cost. A remodeled kitchen might add $50,000 to the value of a home, while the actual cost could have been anywhere from $25,000 to $75,000. Diminishing Return - This condition is a result of continuing to add improvements to a property when those improvements will have no effect on increasing the value of the property. Highest and Best Use - According to this principle, every property has a single use which produces the greatest income and return. Therefore the property will have its highest value when it is used for that purpose. The property's use must be: Legally permissible Physically possible Financially feasible Maximally productive For example, an old office building may not be in its highest and best use if it's located in a downtown area that is undergoing a residential redevelopment. Its best use might be a conversion to high end condominium units. Progression and Regression - This principle holds that a property is affected by the surrounding properties. The value of the "smallest house on the block" will tend to increase if the other homes on the street have more value - progression. On the other hand, the value of the "largest home on the block" may decrease if the other homes on the street are much lower in value - regression. Substitution - According to this principle, a buyer will not pay more for a home than what he or she would pay for another home that is equally attractive and available. For example, if there are several homes for sale in a neighborhood and they are alike in size, quality and amenities, a buyer won't usually purchase the home with the highest price. Supply and Demand - This principle says that the value of a property depends on: How many properties are available in an area Property prices Number of prospective buyers Price buyers are willing to pay For example, if there is only one home available in a highly desirable neighborhood, that home would probably have more value than it would if there were four homes for sale in that same neighborhood.
Qualifying the Property:
Once the lender has determined that the borrower is qualified to receive a loan, the lender will move on to the job of qualifying the property to determine if the property is a good risk. Even though the evaluation of the borrower's qualifications is the primary factor in the loan decision, lenders realize that "life happens." In the long-range scheme of things, borrowers lose jobs, get divorces, and file bankruptcies. In order to mitigate this risk, lenders seek to determine the value of the property as collateral in the event that something unforeseen happens. It is important for the lender to determine the market value of a particular piece of property at any given point in time. It can be said that the market value of a property is the highest price a buyer is willing to pay and the lowest price the seller will accept, under these conditions: The market is open and competitive. The property is exposed in the market for a reasonable period of time. Both buyer and seller are fully aware of market conditions. Both buyer and seller are acting with no undue pressure. Buyer and seller are not related. Both buyer and seller are aware of the property's potential for use. Both parties are aware of the property's assets and defects. The sale is a cash transaction. The property has a marketable title. The price does not include hidden aspects, such as service fees, credits, or special financing terms.
Loan Application:
The loan process starts when a borrower completes a loan application and gives it to a lender for evaluation. Most lenders use some version of the Uniform Residential Loan Application published by Fannie Mae. This form requests that the borrower provide information about both the property and the borrower. Click on the link below to print a copy of the Uniform Residential Loan Application and follow along as we explain each section. Uniform Residential Loan Application At the top of the form is a place for the borrower and co-borrower to sign stating that this application is for joint credit. In this circumstance, the signatures are required BEFORE any personal or financial information is actually taken on either of the borrowers (and the signatures here are ONLY required if the application is for joint credit). Section I: TYPE OF MORTGAGE AND TERMS OF LOAN The borrower fills out this section of the loan application with the help of the lender. Most of the items in this section deal with the type of mortgage, case numbers, amount of the loan, interest rates, etc. The borrower and co-borrower need the lender's input on these items. Section II: PROPERTY INFORMATION AND PURPOSE OF LOAN In this section, the borrower provides the property address of the home. If the property is multi-unit, the borrower needs to provide the number of units. Usually, the property address suffices as the legal description of the subject property, and the actual legal description is not necessary. The borrower indicates the purpose of the loan. Is it a purchase, a refinance, construction or something else? Is the property a primary residence, a secondary residence or an investment? In this section, the borrower also indicates the names and manner in which the title will be held. Other information, such as the source of the down payment, is also indicated in this section. Section III: BORROWER INFORMATION In this section, the borrower provides his or her name, address, Social Security number, home phone, age and information about schooling. This information is also collected for the co-borrower if there is one. If the borrower has resided at the current address for less than two years, a second address is required. Section IV: EMPLOYMENT INFORMATION In this section, the borrower provides the name and address of his or her current employer, the length of current employment, the number of years worked in the current line of work, job title and a phone number. If the borrower has been employed at his or her current employment for less than two years, he or she must complete additional information about previous employment. Section V: MONTHLY INCOME AND COMBINED HOUSING EXPENSE INFORMATION Here the borrower provides monthly income, including overtime or bonus income. This information must be completed for the co-borrower also, if there is one, and combined with the borrower's amounts. This is also the section where a borrower would include income such as child support or alimony if that income will be used to repay the loan. If not, it does not have to be included. Section VI: ASSETS AND LIABILITIES Assets consist of all things of value that are owned by the borrower. Cash consists of money in hand that is on deposit in checking and savings accounts and also any cash given as an earnest money deposit on the property being purchased. Next in the asset column are all monies invested in stocks and bonds and the net cash value of any life insurance policies. All of the above assets are considered liquid assets. The borrower then lists the value of any real estate he or she owns, the net worth of any owned businesses, vested interest in retirement plans and the value of his or her automobiles and other personal property. When the borrower assigns a dollar value to these items, those amounts should reflect current market value, not the purchase price or some other figure. Note: If a borrower has more assets than he or she can list in this section, additional sheets can be attached to the application explaining those assets. Liabilities are what the borrower owes. The borrower lists the creditor's identifying information, including name, address and account number for all outstanding debts. This includes auto loans, charge accounts, real estate loans, medical bills, insurance premiums, etc. The borrower will then list any long-term liabilities, such as alimony and child support payments. Note: Hopefully, the list of assets will exceed the list of liabilities. The difference between assets and liabilities is called net worth. If the total liabilities are greater than total assets, the lender would probably deny the loan at this point and close the file. Section VII: DETAILS OF TRANSACTION This section includes figures relating to purchase price, prepaid items, estimated closing costs, discounts, etc. The lender is primarily responsible for providing most of the information in this section, as the lender would have most of these details rather than the borrower. Section VIII: DECLARATIONS The declarations section includes things such as judgments, bankruptcies, lawsuits, involvement in foreclosures, etc. It also includes information about whether or not the borrower is obligated to pay alimony, child support or separate maintenance. This section of the application must be filled out by both the borrower and the co-borrower, if there is one. Section IX: ACKNOWLEDGMENT AND AGREEMENTS Both the borrower and the co-borrower must sign and date this section of the application. Section X: INFORMATION FOR GOVERNMENT MONITORING PURPOSES The information in this section is requested by the federal government for certain types of loans related to a dwelling in order to monitor the lender's compliance with equal credit opportunity, fair housing and home mortgage disclosure laws. Borrowers are encouraged to fill out this section, but they are not required to do so. It is against the law for a lender to discriminate on the basis of the information provided in this section or on whether or not the borrower chooses to furnish the information. Note: If the borrower chooses not to provide the information in this section, the lender is required to note the information based on visual observation and surname if the borrower makes the application in person.
The three approaches to estimating cost referred to in step five above are:
the sales comparison approach the cost approach the income approach.
Underwriting is the most important and last approval step in the loan process before the loan is forwarded to the loan department to draw up the actual loan documents. This process is so important because
the underwriter is the last person who is in a position to protect the investor. -The underwriter's job is to approve or deny the loan and, because of this, the underwriter needs the highest level of expertise possible. Since "underwriting schools" don't exist and underwriters are not certified or degreed, underwriters must work their way up through the industry to gain the high level of expertise lenders depend on. - Most lenders use either an individual loan underwriter or a loan committee to approve loans. The committee is usually made up of loan underwriters and senior personnel of the lending institution, such as the vice president of loan operations. The loan underwriter is in a position of high responsibility for the protection of the investor's funds by reducing the exposure the lender would have for liability if the loan is funded.
Underwriting often works in the following way in most institutions:
- For loan amounts up to Fannie Mae or similar maximum loan limits, the underwriter approves all loans submitted to the lender. - For Fannie Mae maximum loan amounts, it takes two underwriters to deny the loan package, while only one underwriter is necessary to approve the loan. - For jumbo loans, a loan committee must approve the file.
Check Your Understanding-Answers:
- What are the four critical procedures for processing a loan? Determine the ability of the borrower to repay the loan Estimate the value of the property that is collateral for the loan Research and analyze the marketability of the title. Prepare the documents necessary to approve the loan and close the transaction. - Define underwriting. The evaluation process used to determine the borrower's ability to repay a loan and estimating the value of the property being used as collateral. - Who usually performs the underwriting tasks? The loan officer at the financial institution - What is detailed in the Assets and Liabilities section of the loan application? All things of value that are owned by the borrower, including cash, stocks, bonds, life insurance policies, value of real estate owned, value of businesses, and value of automobiles and other personal property are detailed in the assets section. What the borrower owes, including auto loans, charge accounts, real estate loans, medical bills, insurance premiums and any long-term liabilities such as alimony and child support payments are detailed in the liabilities section.
Check Your Understanding-Answers::
-Explain the difference between market value and market price. Market value is an opinion of the value of a property based on analyzing data collected about the property. The market price of a property is the actual sales price. - What does the term anticipation mean as it relates to property value? The benefits a buyer expects to receive over the period of time he or she holds the property. - What are the four levels of appraiser licensing? Trainee License Residential License Certified Residential License Certified General License - What are the three approaches to estimating a property's value? Sales comparison approach Cost approach Income approach
Check Your Understanding-Answers:
What is the Request for Verification of Deposit form? A verification form that allows the bank to give the lender information about current balances in the borrower's accounts. What kinds of information does an employer provide on the Verification of Employment form? The information includes the borrower's wages and length of employment, an opinion of the borrower's attitude on the job, the probability of continued employment and a prediction of what the borrower's prospects are for pay increases or promotions. What is the most important part of the credit report? The borrower's payment history. Name two red flags that might appear on a borrower's credit report. (See other correct answers on screen 17.) The employment or residence data on the credit report is different from the application. There are several recent inquiries from credit card companies or other mortgage lenders
Uniform Residential Appraisal Report:
As we said on an earlier screen, the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) of 1989 requires that real estate appraisals be in writing and be performed by competent individuals in accordance with a set of uniform standards. The Uniform Residential Appraisal Report (URAR), referred to as the 1004 Form, has become the standard in the industry. This report requires the appraiser to do all of the following tasks: Perform a visual inspection of the interior and exterior areas of the subject property. Inspect the neighborhood. Inspect each of the comparable sale properties (at least from the street). Collect, confirm and analyze data from reliable public or private sources. Submit his or her analysis, opinions and conclusions in the report. In addition to completing the report, the appraiser submits all of the following exhibits. A street map that shows the location of the subject property and the comparables. An exterior building sketch of the improvements, indicating the dimensions and including calculations to show how the appraiser arrived at the estimate for gross living area. If the floor plan is not typical or is functionally obsolete, the appraiser can include a floor plan sketch with the dimensions instead of the exterior building sketch. Photographs showing the front, back, and a street scene of the subject property. Photographs showing the front of each comparable sale property. Any other attachments that will provide support to the appraiser's opinion of market value.
Summary/Review::
At the same time the underwriter is reviewing financial and employment information, the underwriter will also send a request for a borrower's credit reports to the three reporting agencies. The credit report indicates the status of current and past accounts. It indicates the dates that payments were made and how regularly they were made, whether or not they were delinquent or if there are any outstanding balances. The borrower's payment history is the most important part of the report. Once the loan processor has reviewed all of the information provided with the application, in addition to all other information that was collected, he or she will decide either to approve or reject the loan application. Once the lender has determined that the borrower is qualified to receive a loan, the lender will move on to the job of qualifying the property to determine if the property is a good risk. It is important for the lender to determine the market value of a particular piece of property at any given point in time. The Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) of 1989 requires that real estate appraisals be in writing and be performed by competent individuals in accordance with a set of uniform standards. There are three approaches to estimating the value of a property: Sales comparison approach Cost approach Income approach The Uniform Residential Appraisal Report (URAR), referred to as the 1004 Form, has become the standard in the industry. This report requires the appraiser to do all of the following tasks: Perform a visual inspection of the interior and exterior areas of the subject property. Inspect the neighborhood. Inspect each of the comparable sale properties (at least from the street). Collect, confirm and analyze data from reliable public or private sources. Submit his or her analysis, opinions and conclusions in the report. After the underwriting process is complete and after the lender and borrower have negotiated, if the loan is approved, the lender will issue a loan commitment.
Evaluating the Borrower's Credit Report:
Even though there are many standardized forms used in the lending procedure, the analysis and evaluation of the borrower's credit ability is still the area where there is the greatest amount of interpretation. The evaluation of a borrower's ability to pay can be very subjective, depending on an evaluator's unintentional bias or the lender's changing policies. Credit standards sometimes change when the lender's monetary position changes. When money is limited in the market, the standards are higher. When money is in large supply in the market, the standards are lower. Depending on the market conditions, a borrower might be eligible for a loan at one point in time, but not in another. As mentioned earlier, lenders typically use qualifying ratios to determine whether or not a borrower will qualify for a loan. The amount of money a borrower has available to repay the loan weighs heavily in the lender's decision. Persons who are divorced may be required to submit a copy of their divorce decree so that the lender can see which person is responsible for which payments, how assets are divided, and whether or not there are obligations for child support or alimony. Experienced loan processors can quickly decide whether or not the borrower can meet minimum requirements for repaying the loan by looking at the employer verification form and the amount of the loan, and then doing a comparison of the monthly payroll information with the required monthly payments. In addition, if the borrower's credit report shows a pattern of late or missed payments, the loan processor would probably recommend that the loan be denied and the file closed without further evaluation. However, if the credit report shows just a few late payments and everything else looks good, the lender will probably give the borrower a chance to explain those entries in writing for placement in the file. Evaluating the Borrower's Credit Report When determining whether or not the borrower can support his or her family and make the required monthly loan payments, the loan processor will evaluate both the quantity and quality of the applicant's income. When evaluating quantity, the underwriter will review the family's total income, which may include both the borrower's income and a spouse's income. Even though extra sources of income can be included, there are some reservations. For example, a person's bonus might be accepted as a source of income, but only if those bonuses are given on a regular basis. If a borrower will rely on commissions as a large part of the repayment ability, the underwriter will have to scrutinize the history of past earnings to decide whether or not the commissions are stable enough to be considered as a source for payments. Likewise, an underwriter will not include overtime wages in the analysis, unless those wages will continue to be earned consistently. With regard to the quality of a borrower's income, the underwriter will ask the employer for his or her opinion about the borrower's attitude at work, the stability of the job and the possibility for future promotions or advancements. Years ago, persons who "job hopped" from one job to another were considered poor risks. However in today's economy, borrowers who change jobs frequently, but whose income history shows that those job shifts were upward, are considered good candidates.
Appraiser Requirements Changes:
OREA License Levels Current Education Requirements and New (1-1-08) Education Requirements College Level Requirements have not changed and are as follows: Residential 150 hours Certified Residential 200 hours Certified General 300 hours College Level Requirements: Residential: None Certified Residential: Assoc Degree and 21 hours Certified General: Bach Degree and 30 hours Experience: Residential: 2,000 over 12 months Certified Residential: 2,500 over 30 months,000 Hours Certified General: 3,000 hours that include at least 1500 non-residential hours (accumulated over at least a 30-month period) EA website at www.orea.ca.gov. IMPORTANT: A real estate licensee may provide a comparative market analysis (CMA) showing the selling prices of other similar properties, but the licensee can never call this an appraisal unless he or she also holds a separate appraisal license.
Once the borrower has submitted the loan application to the lender, the actual underwriting process begins. The underwriter must evaluate the borrower's ability to repay the loan.
One of the principal risks a lender undertakes is the fact that the borrower might default on repayment of the loan and that the borrower will damage the value of the property as security. In addition, the lender runs the risk that, in the event of a foreclosure, the sales proceeds from the property will not be enough to cover the lender's loss. To qualify for a mortgage loan, a borrower must meet the lender's qualifications in terms of income, debt, cash, and net worth. In addition, the borrower must demonstrate sufficient creditworthiness to be an acceptable risk. The loan officer who will be doing the underwriting will verify all of the information included on the application by actually contacting the references given. The underwriter will check the banks where the borrower has deposits and will check with the borrower's employer or employers. The borrower must sign a verification form that allows the bank to give the lender information about current balances in the borrower's accounts. The typical form used to verify deposits is called the Request for Verification of Deposit. Click on the link below to print and see a copy of this form. Request for Verification of Deposit On this form, the lender must complete items one through eight. The borrower will complete item nine. Then the lender will forward the form to the financial institution named on the form. Once the lender has received the deposit verification forms back from the various financial institutions, the information will be entered into the borrower's file.
The next thing the underwriter will check is the borrower's employment status. Just like for the verification of deposits, there is a form called Request for Verification of Employment that the lender will use to collect the employment information. Click on the link below to print and see a copy of this form.
Request for Verification of Employment On this form, the lender must complete items one through seven and the borrower will complete item number eight, and then the lender will forward the document to the employer for completion. By signing this form, the borrower authorizes his or her employer to reveal confidential information about his or her job status. The information includes the borrower's wages and length of employment. The employer will also be asked to give an opinion of the borrower's attitude on the job, the probability of continued employment and a prediction of what the borrower's prospects are for pay increases or promotions. Once the lender has verified the borrower's employment with regard to income, the lender will try to estimate the applicant's ability to fulfill the loan obligation. The lender will do this by establishing an income ratio and a debt ratio. As we mentioned in an earlier unit, the income ratio establishes the borrower's capacity to pay by limiting the percent of gross income a borrower may spend on housing costs. Housing costs include the principal, the interest, the taxes and homeowner's insurance, and also may include some monthly assessments for mortgage insurance and utilities. Conventional loans typically require this ratio to be under 28 percent, but as we saw earlier, FHA guidelines require the income ratio to be no more than 29 percent. In addition to the income ratios, the lender will use the information on the verification of deposit forms to assess if the borrower has the funds to make the required down payment. If some of the borrower's cash for the down payment comes as a gift from a relative or friend, the lender will probably require a gift letter from the person making the donation that states the amount of the gift and verifies that no repayment is required. Conversely, if the borrower is receiving a portion of the down payment as a loan from another person, the lender will consider this just another debt obligation and go back and refigure the debt ratio accordingly. The underwriter will examine the assets and liabilities section of the borrower's application very carefully. The information about the borrower's net worth is important to the lender, as it gives indication of the borrower's ability to sustain payment of the debt in the event that the borrower would lose his or her job. A borrower's debt ratio is calculated based on all of the monthly obligations the borrower has, including those items or payments the borrower must make for other debts. These debts could be car payments, revolving charge accounts, etc. Again, conventional loans usually require the debt ratio be 36 percent or lower, but FHA guidelines state the debt ratio may not be greater than 41 percent.
Appraiser Requirements:
Since the value of a piece of property changes from one point in time to another, each piece of property must be inspected and appraised carefully to get a proper estimate of its fair market value. Depending on what type of loan the lender wants to issue and the current loan to value ratio, the lender will base the loan amount on either the amount of the appraisal or the purchase price, whichever is less. Lenders who are active in the real estate market usually have experienced appraisers on their staff who are charged with estimating and verifying property values. Lenders who are not as active in the real estate market hire professional appraisers to get an opinion of the property. By definition, an appraisal is an opinion or estimation of a property's value at a specific point in time. How accurate the appraisal is depends on who does it. The Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) of 1989 requires that real estate appraisals be in writing and be performed by competent individuals in accordance with a set of uniform standards. In addition, appraisers must pass an exam that is endorsed by the Appraiser Qualifications Board of the Appraisal Foundation and receive a state license or certification. In California, the Bureau of Real Estate Appraisers (BREA) enforces the FIRREA law. Currently, four levels of appraiser licensing exist. Trainee License - Cannot perform an independent appraisal; must work under the supervision of a licensed appraiser. Residential License - Allows appraisal of both residential and non-residential properties with restrictions on complexity and value of the property. Certified Residential License - Allows appraisal of residential properties with no restrictions and non-residential properties with restrictions on value. Certified General License - Allows appraisal of all property types with no restrictions. Note: A certified residential license requires a minimum of an associate's degree or higher, and the certified general license requires a bachelor's degree or higher. See the table on the next screen.
Credit Report Red Flags:
Some red flags that might appear when the underwriter is reviewing the credit report are the following: The employment or residence data on the credit report is different from the application. There are several recent inquiries from credit card companies or other mortgage lenders. The Social Security number is invalid. The length of the credit history is inconsistent with the borrower's age. The co-borrower's maiden name is different from the data indicated on the application. The borrower is over 25 and has no credit history. Personal data on the credit report is not consistent with what is on the borrower's application. Late payments on the credit report due to unemployment, illness or layoff do not match the Verification of Employment form data.
An important job of the underwriter is to become alert to any possible red flags in the loan application or other documents. These red flags are not necessarily indicative of fraud. However, seeing any of these items should alert the underwriter that the application or documents need further review.
Some things that might "pop out" of the loan application include the following: The new house being purchased is not large enough for all of the occupants. The down payment is something other than cash. The face value of a life insurance policy is shown as a liquid asset, but it is not a cash surrender policy. The value of personal property is greater than one year's salary. A high income borrower has no personal property. The new housing expense exceeds 150% of the current housing expense. The salary amount seems inappropriate with respect to the amount of the loan. Social Security number is invalid. A high income borrower has no credit and/or no cash. A low income or young borrower has a substantial amount of cash in the bank. A high income borrower has little or no cash in the bank. A high income borrower has furniture rental debt through a finance company. A self-employed borrower has no business credit cards. Information on the application is inconsistent with other loan documents. There are significant changes or contradictions from a handwritten application to a typed application.
Appraisals and the Borrower:
The borrower is entitled to receive a copy of the appraisal report if he or she paid for it. Some lenders do not charge the borrower for the report, and, therefore, they don't have to give a copy to the borrower. In California, if the borrower pays for the appraisal when working with a licensed mortgage loan broker, the broker must provide a copy of the appraisal to the borrower and a copy to the lender at or before the closing of the loan transaction. California law requires the lender to provide notice to loan applicants informing them that they have the right to a copy of the appraisal if they paid for it. This notice must be given in 10-point bold type as a separate document no later than 15 days after the lender received a written application for the loan. Release of the appraisal to the applicant may be conditioned upon payment of the cost of the appraisal.
Underwriting:
The evaluation process used to determine the borrower's ability to repay a loan and estimating the value of the property being used as collateral is called underwriting. -Underwriting will determine whether a borrower and property meet the minimum requirements established by the lender, the investor or the secondary market (into which the lender will probably sell the loan). - Underwriting is usually performed by a loan officer at a financial institution and is based on information contained in the borrower's loan application and an appraisal of the property. The analysis is usually made in the context of a lending policy or guidelines that the particular institution specifies. - In some cases, the lender will require the borrower to obtain default insurance. The borrower purchases this insurance policy to protect the lender from potential losses if the borrower defaults on the loan. In those cases, the lender is not willing to bear the total risk of the borrower default or the lender may be planning to sell the loan to a third-party investor. If the lender plans to sell the loan to a third-party investor, the lender must consider the underwriting standards those other investors require; otherwise, the lender may lose the option of selling mortgages later.
When a lender is processing a loan, there are four critical procedures involved.
The lender or its designee must: Determine the ability of the borrower to repay the loan. Estimate the value of the property that is collateral for the loan. Research and analyze the marketability of the title. Prepare the documents necessary to approve the loan and close the transaction.
At the same time the underwriter is reviewing financial and employment information, the underwriter will also send a request for a borrower's credit reports to the three reporting agencies that we talked about in an earlier unit.
The lender should receive the borrower's report within a few days. The report will usually have a borrower's age, his or her address, whether the borrower is a tenant or an owner of a residence, the amount of time the borrower has lived at the current address, a brief employment history, and a profile of the person's credit, both past and present. Most of this data is collected from banks, merchants and other credit services. The credit report is a compilation of the information that's accumulated by not only checking the information on the application but also by checking public records to discover if there's anything pending against the borrower, such as lawsuits, judgments, bankruptcies, foreclosures, wage garnishments or defaults. The credit report indicates the status of current and past accounts. It indicates the dates that payments were made and how regularly they were made, whether or not they were delinquent or if there are any outstanding balances. The borrower's payment history is the most important part of the report. Lenders frequently believe that a person's future actions reflect past behavior when it comes to finances. Research indicates that slow payers generally remain slow payers. Conversely, persons who are prompt in their payments usually remain so in the future. As we mentioned in an earlier unit, lenders typically assess how likely a borrower is to pay off his debts by using a credit score. The credit reporting agencies use past payment history, the types of credit the borrower has used, outstanding debt and other factors to evaluate and score a particular borrower. Lenders use these scores to decide whether or not to lend money to a borrower, and if so, under what terms.
Loan Commitment:
The loan application that was completed by the borrower and submitted to the lender is not a binding contract. The application represents a way to gather information about the loan, the borrower and the property. After the underwriting process is complete and after the lender and borrower have negotiated, if the loan is approved, the lender will issue a loan commitment. The loan commitment is binding. It details the loan amount and the terms on which the lender is willing to lend. The commitment usually carries an expiration date, setting the time by which the borrower must accept the terms of the loan offer or lose the commitment.
Market Value Versus Market Price and Cost:
The market value of a property is an opinion of the value of a property based on analyzing data collected about the property. The analysis could include information about potential income and expenses to the property in addition to the analysis of comparable properties that have sold previously. The market price of a property is the actual sales price. It would be ideal if the market value and the market price were the same. However, in some circumstances they are not. If a seller is forced to sell because of a transfer, for example, the property could sell well below market value. On the other hand, a property could sell above market value if the property is in a "hot" market area or if the price of the property includes personal property. Oftentimes people have the misconception that market value and cost are the same. This could be true with new construction - the cost to build a home may be equivalent to its market value. However, in many other cases, cost and market value don't correspond. For instance, a homeowner can spend $25,000 to finish the basement, only to discover that he or she has not added $25,000 to the value of the home and may never be able to recoup that cost at resale.
The Appraisal Process:
The process of conducting an appraisal includes seven definite steps. 1) Identify the purpose of the appraisal, such as market value for a purchase or value as loan collateral. 2) Gather the data relevant to the property, such as tax and title records, costs and demographic and economic data. 3) Assess the highest and best use of the property by analyzing market conditions. 4) Estimate the value of the land. 5) Use the three approaches to estimating cost to help reduce errors and establish a "range" of value. 6) Reconcile the estimates from the three approaches into a final value estimate. 7) Compile and present a formal report to the client.
Some red flags that might appear when reviewing the Verification of Employment form include the following:
There is an employment overlap between the current and previous employment. There are no prior year's earnings. All of the dollar amounts are rounded off. The borrower was hired on a weekend or holiday. Most of the income comes from commissions. A prior employer is now out of business. The borrower changed professions from the previous employer to the current employer. The current business entity is not in good standing with regulatory agencies. The verification form says the borrower has a company car, while the application shows the borrower has an automobile loan. The income is out of line with the kind of employment. There are several whiteouts, cross-outs, or squeezed in numbers.
Red flags that might appear when evaluating the Verification of Deposit forms include the following:
There is not sufficient cash in the bank to close the loan. The bank account is brand new. The bank account is not in the borrower's name. A gift letter is not backed up by any bank statements or canceled checks. The borrower really has no bank accounts (says he doesn't believe in banks). An IRA is shown as a liquid asset or as a source of the down payment. There are significant changes in a balance from the prior two months to the day the verification is done. There is an excessive balance in the borrower's checking account. The date the verification was done by the bank is a weekend or holiday. The checking accounts have an average two-month balance that is exactly equal to the present balance.
Summary/Review:
When a lender is processing a loan, there are four critical procedures involved. The lender or its designee must: Determine the ability of the borrower to repay the loan. Estimate the value of the property that is collateral for the loan. Research and analyze the marketability of the title. Prepare the documents necessary to approve the loan and close the transaction. The evaluation process used to determine the borrower's ability to repay a loan and estimating the value of the property being used as collateral is called underwriting. Underwriting is usually performed by a loan officer at a financial institution and is based on information contained in the borrower's loan application and an appraisal of the property. Underwriting is the most important and last approval step in the loan process before the loan is forwarded to the loan department to draw up the actual loan documents. The loan process starts when a borrower completes a loan application and gives it to a lender for evaluation. Most lenders use some version of the Uniform Residential Loan Application published by Fannie Mae. Once the borrower has submitted the loan application to the lender, the actual underwriting process begins. The underwriter must evaluate the borrower's ability to repay the loan To qualify for a mortgage loan, a borrower must meet the lender's qualifications in terms of income, debt, cash, and net worth. In addition, the borrower must demonstrate sufficient creditworthiness to be an acceptable risk. The loan officer who will be doing the underwriting will verify all of the information included on the application by actually contacting the references given. The underwriter will check the banks where the borrower has deposits and will check with the borrower's employer or employers.
Appraisers use the income approach to:
estimate the value of properties that produce income, usually from rent paid on leases. This method is best for estimating the value of apartments, stores, shopping centers, and office buildings.
The sales comparison approach is based on:
the principle of substitution, which says that a buyer will not pay more for the subject property than he or she would pay for a property that is similar in characteristics and amenities. With this approach, the value is determined by comparing the property being appraised with recently sold comparable (equivalent) properties.
