Chapter 17 - Finance: Pre-Approval Through Loan Commitment

Consumer debt

can be car payments, credit card debt, installment loans, and similar expenses. Car or life insurance, utility bills, and cell phone bills are not used to calculate the ratio. The back ratio for FHA loans is 43%.

"Three Cs" of credit

capacity, credit, and collateral. If one of these components is not acceptable, the home loan may not be acceptable for sale to Fannie Mae or Freddie Mac.

Prior-to-documents conditions (PTDs)

conditions that must be met before drafting loan documents, funding the loan, or closing escrow. The loan commitment letter states that the lender is committed to making a loan to the borrower according to the terms stated in the commitment letter. The loan commitment letter usually indicates the type of loan, the amount of the loan, the length of the repayment period, and the interest rate assigned to the loan. Loan commitments often are conditional, which means they come with a list of conditions that must be met before the file can move forward. It is important to understand that this conditional approval eventually expires, so the borrower must satisfy all of the conditions as quickly as possible. After the conditions are met, the loan documents can be ordered, and the lender can move on to the closing process.

Actual cash value

covers a structure at the depreciated value of the loss. If a building is 10 years old, the structure is considered to have depreciated to a lesser value over the last 10 years. When the building is insured for actual cash value, the amount paid is equal to today's cost to replace the structure minus depreciation.

Replacement value

covers a structure for the amount it will cost to rebuild or replace lost or damaged property with new property of like kind and quality in the local market.

Risk

defined as the possibility of suffering a loss or misfortune

mortgage underwriter

determines whether the borrower has the ability and willingness to repay the loan and whether the property is adequate security for the loan. The underwriter is a credit analyst whose job is to determine if the loan in question is an acceptable risk for the lender.

Model Loan Estimate Forms

different types of closed-end mortgage products, including fixed-rate loans, interest only adjustable-rate loans, loan refinances, and loans with balloon payments and negative amortization.

appraiser or valuation independence

have no affiliation with the lender, the real estate agents, the seller, or the buyer. .third-party appraisers / appraisal management companies (AMCs),

Mortgage loan originators (MLOs)

help borrowers select a home loan product and loan processors help borrowers through the loan process, loan funding, and closing.

signed loan application

help the lender decide whether to lend money to the borrower. In addition, borrowers must provide the previous two years' tax returns and W-2s, thirty days of pay stubs, and sixty days of bank account statements. These documents help the lender gauge the borrower's willingness and ability to repay the loan.

appraisal report.

his or her opinion of value in a written statement

Types of Insurance

homeowners insurance, flood and other disaster insurance, mortgage insurance, and title insurance.

loan processor

in charge of processing the loan and performs clerical or support duties

loan docs

include a promissory note and a security instrument, plus many pages of statements, disclosures, riders, and other documents depending on the type of the loan.

Page 2 of the Loan Estimate

includes closing cost details (Loan Costs, Other Costs, and Calculating Cash to Close tables). For transactions with adjustable payments or adjustable interest rates, an Adjustable Payment (AP) table or an Adjustable Interest Rate (AIR) table is provided.

Page 3 of the Loan Estimate

includes the applicant's contact information and provides additional information about the loan.

Page 1 of the Loan Estimate

includes the name and address of the lender and the statement "Save this Loan Estimate to compare with your Closing Disclosure." This is important because the numbers on the Loan Estimate should not vary substantially from the numbers on the Closing Statement. Page 1 also includes the applicant's name, property address, sales price, and the type of loan and loan terms. The main sections of page 1 of the Loan Estimate are the Loan Terms, Projected Payments, and Costs at Closing tables.

loan commitment letter

indicates the type and amount of the loan, the length of the repayment period, the interest rate, and any "prior-to-documents" conditions

Larger Down Payments

lower the LTV ratio on the loan and reduce risk to the lender. Borrowers with a sizable down payment are less likely to default. Lenders do make loans with higher ratios, but these loans inherently involve more risk for the lender.

credit history

meeting payments in a timely manner according to contract terms

deficiency

occurs when the amount for which the property sells is less than the total amount due to the lender. Neither is desirable from the point of view of the lender or investor. Therefore, it is important for the underwriter to determine if the LTV falls within the guidelines for that particular loan.

PITI

pay housing costs, including principal, interest, taxes, and insurance

Underwriting guidelines

principles lenders use to evaluate the risk of making real estate loans Lenders who expect to sell their loans in the secondary market use underwriting guidelines that adhere to Fannie Mae and/or Freddie Mac standards

Two types of homeowner policy

property coverage and liability coverage.

Homeowners insurance

property insurance that covers the main residence and any attached additions if they are damaged by such perils as fire, windstorm, lightning, theft, or vandalism. Other detached structures like garages, sheds, fences, and cottages on the property are also covered.

capacity

refers to the borrower's financial ability to repay a home loan and is one of the three determining factors of credit. In other words, can the borrower repay the debt? Lenders ask for employment information such as the borrower's occupation, how long the borrower has worked for his or her current employer, and the borrower's earnings. Lenders may also consider the borrowers' savings or cash reserves as income and use them to assess capacity. Lenders want to know the borrower's expenses, the number of dependents supported, if the borrower pays alimony or child support, and the amount of any other obligations.

funding

refers to when the lender actually "funds" (provides the money to finance) the loan.

Ability-to-Repay Rule (ATR)

requires that a lender make a "reasonable and good faith determination at or before consummation that the borrower will have a reasonable ability to repay the loan according to its terms." The lender must follow underwriting requirements and verify the information by using reasonably relied upon third-party records.

debt-to-income ratio (DTI)

simply the percentage of a borrower's monthly gross income that is used to pay his or her monthly debts. Lenders use the DTI ratio to measure a borrower's ability to repay a home loan.

Collateral

something of value given as security for a debt. This is because the lender wants to be fully protected in case the borrower fails to repay the debt.

Residential Mortgage Credit Report.

standardized credit report

Uniform Residential Loan Application (Freddie Mae Form 65/Fannie Mae Form 1003)

standardized loan application Fannie Mae and Freddie Mac require the use of this form for all loans that are sold to them. Since lenders sell a large number of loans to Fannie Mae and Freddie Mac, it is much easier to use Form 1003 for their residential loans instead of having different forms for conforming and non-conforming loans. The Uniform Residential Loan Application is also approved for use in processing FHA, VA, and USDA loans.

Repayment ability

the borrower has the financial ability to repay the loan

suspended

the borrower will need to supply additional information or documentation to move it to approved status

rejected

the borrower will probably apply to another bank or mortgage lender.

Verification of Deposit (VOD)

the documentation that establishes the existence and history of funds to be used for a down payment and determines how long the funds have been in the account. Most lenders require borrowers to pay some kind of down payment to show that they have a monetary interest in the property. The belief is that the borrower protects his or her interest to a greater degree if there is some personal money invested in the purchase. a form completed by the borrower's bank to confirm the status and balance of the borrower's bank accounts.

loan package

the file of documents the lender needs to determine whether to fund a loan. documents in the loan package include the loan application, income documents, verifications, credit report, and information on the property. in charge of checking the credit history of potential borrowers. If any credit issues are found, such as bankruptcies, late payments, or problems with property, the processor usually notifies the applicant. ensure that all of the information in the loan package is correct

down payment

the initial equity the borrower has in the property. Lenders use a Verification of Deposit to check the borrower's bank account to confirm the money for the purchase is currently on deposit. is equal to the difference between the amount borrowed and the value of the property. If the appraisal is below the asking price of the home, the down payment the borrower plans to make and the amount the lender is willing to lend may not be enough to cover the purchase price.

front ratio

the percentage of the borrower's monthly gross income (before taxes) that is used to pay housing costs, including principal, interest, taxes, and insurance (PITI).

Underwriting

the practice of analyzing the degree of risk involved in a real estate loan

loan-to-value ratio (LTV)

the relationship between the loan (amount borrowed) and the value of the property. A common LTV ratio is 80%, but lenders often originate loans with LTVs of 90% or higher. For example, if the property in question is valued at $100,000, and the loan amount requested is $80,000, the loan-to-value ratio is 80%.

Loan processing

the steps taken by a lender from the time the application is received to the time the loan is approved.

application

the submission of a borrower's financial information for the purposes of obtaining an extension of credit. For loan applications submitted in anticipation of obtaining a federally related mortgage loan, six elements are required.

back ratio

the total monthly PITI and consumer debt divided by the gross monthly income.

risk facts associated with approving a real estate loan

the type and value of the collateral (single-family, condominium, duplex, or rental) used as security for the loan.

The basic steps in the loan process

(1) completing the application (origination), (2) loan processing, (3) underwriting, (4) loan approval and commitment letter (5) funding and closing.

four categories of data that have been collected and reported to the credit bureaus

1) personal information, (2) credit information, (3) public record information, and (4) inquiries. According to the Equal Credit Opportunity Act (ECOA), the credit report does not include certain factors such as gender, income, race, religion, marital status, and national origin.

What are the differences between a credit report, credit history, and credit score?

A credit report is a document that lists an individual's credit history. A credit rating is a formal evaluation given by credit bureaus of a borrower's ability to handle new credit based on past performance. A credit score is a statistical summary of the information contained in a consumer's credit report.

conditional loan approval.

Assuming the loan is approved, it is usually approved "with conditions"

Capacity Example: DTI Ratio for a Conforming Loan

Becky earns $3,600 monthly and wants to purchase a 2-bedroom bungalow in an urban neighborhood that is close to work. She has saved $45,000 for the down payment and has paid off all of her debts with the exception of a $375 car payment. She found the perfect property listed for $180,000 and wants to put in an offer but is not sure if she will qualify for an 80/20 conventional conforming loan. Since the current interest rate is 4%, her monthly principal and interest payment is $687.48. For homes in the area, monthly property taxes are 1% of the sales price and monthly hazard insurance is $40. Does Becky qualify for the $180,000 loan? Yes, her DTI is 35%, which meets the debt-to-income ratio. No, her DTI is 35%, which does not meet the debt-to-income ratio. Yes, her DTI is 38%, which meets the debt-to-income ratio. No, she does not meet the DTI ratio. Determine the PITI. The monthly principal and interest payment is $687.48. The monthly property tax payment is $150.00 ($180,000 x 1% = $1,800 / 12 months). The PITI is $877.48 ($687.48, $150.00 property tax, and $40 hazard insurance.) Calculate the debt-to-income: $3,600 monthly income x .36 = $1,296 allowed for housing expense and recurring debt. Becky's total PITI ($877.48) and recurring debt is ($375) is $1,252.48, which is 35% DTI ($1,252.48/$3,600 = 34.8%). This meets the 36% DTI ratio.

What 6 elements are required by the TRID Rule for an application?

Borrower's name Borrower's monthly income Borrower's social security number to obtain a credit report Property address Estimate of the value of the property Mortgage loan amount

Six Elements Required by the TRID Rule for an Application

Borrower's name Borrower's monthly income Borrower's social security number to obtain a credit report Property address Estimate of the value of the property Mortgage loan amount A lender must have all six pieces of required information before it is considered an application.

Collateral Options

Borrower's total equity or down payment Property type: a 1-unit or 2- to 4- unit detached property, condominium unit or manufactured home Property use: primary residence, second home, or investment property

Name the factors known as the "Three Cs" of credit.

Capacity, credit, and collateral

Some Standard Prior to Documents Conditions (PTDs)

Clear title Appraisal value exceeds loan amount Mortgage insurance Hazard and possibly flood insurance Lender's policy of title insurance Survey Termite inspection and certification Other inspections common in the area (radon, lead paint, mold or water quality)

Most lenders provide borrowers with a loan commitment letter that has "prior-to-documents" conditions (PTDs). List 3 standard PTDs.

Clear title Appraisal value exceeds mortgage amount Mortgage insurance Hazard and possibly flood insurance Lender's policy of title insurance Survey Termite inspection and certification Other inspections common in the area (radon, lead paint, mold or water quality)

Common DTI Ratios

Conforming loans use DTI ratios that range from 36% to 45%. FHA uses 31% front ratio and 43% back ratio (31/43) VA only uses back ratio of 41% as a guideline USDA uses a 29% front ratio and 41% back ratio.

Types of Reasonably Reliable Third-Party Records

Copies of the borrower's federal or state tax returns W-2 forms or other IRS forms for reporting wages or tax withholding Payroll statements Financial institution records, such as bank account statements Credit reports Statements for student loans, auto loans, credit cards, or existing home loans Court orders for alimony or child support Statements provided by a homeowners association Military leave and earnings statements

Credit Reputation

Credit Score Foreclosures, bankruptcies, liens, or judgments Home loan delinquencies Credit delinquencies, repossessions, collections, or charge-offs Credit accounts: type, age, limits, usage, and status of revolving accounts Borrower's request for new credit in the last 12 months

Eight Underwriting Factors Used to Determine a Borrower's ATR

Current or reasonably expected income or assets, other than those used to secure the loan Current employment status, if income is used as a basis for determination Expected monthly payment on the covered transaction Monthly payment on any simultaneous loans Monthly payment of mortgage-related obligations. Current debt obligations, alimony, and child support Debt-to-income ratio or residual income Credit history

Capacity Info Needed

Debt ratios: qualifying monthly housing expense-to-income ratio or monthly debt payment-to-income ratio Salaried versus self-employed borrower Cash reserves Number of borrowers

In general, what do lenders use to assess a borrower's capacity?

Debt-to-income ratios

Three Major Credit Bureaus

Experian® - experian.com Equifax® - equifax.com TransUnion™ - transunion.com

conditional loan approval

If the loan is approved, it is usually approved with conditions

Risk of loans for borrower

Interest rates and points are increased to offset this risk, and the buyer is normally required to purchase mortgage insurance on most loans that exceed an 80% LTV. The risk to the lender is the risk that the borrower will default on loan payments, thereby causing the property to go into foreclosure.

QM Product Feature Requirements

Loan has regular, equal periodic payments Mortgage cannot have negative amortization, interest-only payments, or balloon payments Maximum loan term is 30 years or less Total points and fees do NOT exceed 3% of the loan amount (for loan amounts less than $100k)

List items typically found on a pre-approval letter.

Loan program Loan type Loan amount Purchase price Qualified interest rate

Items Typically Included in a Pre-approval Letter

Loan program Loan type Loan amount The purchase price The qualified interest rate

Consumer Financial Protection Bureau (CFPB) published:

Model Loan Estimate Forms

What is the difference between pre-qualification and pre-approval?

Pre-qualification refers to an informal evaluation of the creditworthiness of potential borrowers and gives borrowers a general idea of the amount of money that they can borrow. Pre-approval refers to a preliminary evaluation of a potential borrower's income, employment history, assets, and credit history.

VOE Information the Underwriter Checks

Probability of continued employment with the same employer Consistency between actual dates of employment and those on the application Presence of employer's signature Consistency between salary/wages and the amount on the application Minimum of 2 years of employment with current employer (if not, a VOE from the former employer is requested) Likelihood that overtime/bonus income will continue

Other Loan Conditions

Property condition contingencies (repairs that must be completed before closing) Document contingencies (additional documents that the lender wants as proof of income or financial condition) Other requirements (the loan may be contingent on the sale of other property, paying off a debt, or resolving a legal problem)

What is repayment ability?

Repayment ability means that the borrower has the financial ability to repay the loan.

prior-to-funding conditions

Sometimes there are still items that must be satisfied before the lender will fund the loan

What is a loan-to-value ratio (LTV)?

The loan-to-value ratio (LTV) is the relationship between the loan (amount borrowed) and the value of the property.

Loaner Security

The property itself is the lender's primary security for repayment of the loan if the borrower defaults. The secondary security is the promissory note, which is the borrower's personal promise to pay. The property must be structurally sound and in good repair. The lender's decision to fund the loan is dependent as much on the value of the property as it is on the borrower's ability to pay off the loan.

hazard insurance

To protect their residential loan investment, The amount of insurance and the insurer must be acceptable to the lender. Typically, the buyer arranges for a full, one-year policy that is paid at closing. In most cases, coverage must be at least equal to the loan balance or the value of the home.

What two verification letters do loan processors typically send out?

Typical verification letters include the Verification of Deposit (VOD) and Verification of Employment (VOE).

Verification Letters

Verification of Deposit (VOD) and Verification of Employment (VOE) A loan processor who is confirming information regarding the borrower of a VA loan must send out a Request for Certificate of Eligibility (COE) to confirm the borrower is sufficiently entitled to a VA loan.

peril

a cause of loss, such as fire or theft. Insurance policies name the perils that are covered or are not covered by the policy The policy pays to repair or rebuild the home—including electrical wiring, plumbing, and heating and air conditioning—if damaged by a covered cause of loss.

pre-approval letter

a conditional commitment from the lender for an exact loan amount. This allows buyers to look for a home at or below that price level. Buyers won't waste their time (or yours) looking at properties that cost too much. A pre-approval letter is proof that the buyer is serious about purchasing a home. The pre-approval letter is generally valid for 60-90 days and is evidence that a lender has verified the borrower's assets, income stream, and credit-worthiness.

insurance policy

a contract in which the insurance company (insurer) agrees to indemnify the policyholder (insured) against loss, damage, or liability resulting from the occurrence of some event.

Loan Estimate

a disclosure that highlights the most important loan information that borrowers need (e.g., interest rate, monthly payment, and the closing costs).

credit report

a document that lists an individual's credit history.

Verification of Employment (VOE)

a form completed by the borrower's employer to confirm the borrower's employment and employment history. Lenders evaluate acceptable employment and income when underwriting loans. The borrower should have at least 2 years of stable and continuing employment. Lenders use the Verification of Employment (VOE) form as part of the process of documenting the borrower's employment history.

Insurance

a form of risk management because it transfers the risk of a loss, from one entity to another in exchange for money. intended to spread any loss from a particular peril over a large insured group.

credit rating

a formal evaluation given by credit bureaus of a borrower's ability to handle new credit based on past performance. Typically, credit ratings are provided in the form of a credit score.

security instrument

a legal document given by the borrower to hypothecate (pledge) the property to the lender as collateral for the loan.

qualified mortgage

a mortgage that meets the standards of the ATR Rule. The Consumer Financial Protection Bureau (CFPB) defines a qualified mortgage (QM) as a credit transaction secured by a dwelling that meets the product feature requirements

appraiser

a person who is expected to value property in a competent, objective, and impartial manner.

Looy loos

a person who may want to purchase a home but is not qualified to do so— typically due to a lack of financing. So, at a minimum, before working with buyers they should be pre-qualified. Homebuyers, who are pre-qualified, have an idea of the amount they can borrow and "how much house they can afford."

Pre-approval

a preliminary evaluation of a potential borrower's income, employment history, assets, and credit history. borrowers must complete and sign a loan application

credit score

a statistical summary of the information contained in a consumer's credit report. Credit scores consider both positive and negative information in a credit report. Late payments lower the score, but establishing or reestablishing a record of timely payments raises the score. The credit score affects the interest rate the lender charges the consumer. Generally, consumers with higher credit scores qualify for lower interest rates and lower payments. Borrowers with low credit scores qualify for higher interest rates and higher payments. The loan payment is based on the loan amount, interest, and term of the loan.

promissory note (note)

a written legal contract that obligates the borrower to repay a loan

Request for Transcript of Tax Return

allows lenders to obtain a copy of the tax return directly from the IRS in order to compare the accuracy of the information on the tax return to the applicant's submitted documents (pay stubs, W-2s, and tax returns)

appraisal

an act or process of developing an opinion of value

credit bureau

an agency that collects and maintains up-to-date credit and public record information about consumers. A credit bureau is also called a credit-reporting agency.

Pre-qualification

an informal evaluation of the creditworthiness of potential borrowers. It gives borrowers a general idea of the amount of money that they can borrow. Loan pre-qualification does NOT include an analysis of a potential borrower's credit report or an in-depth look at his or her ability to purchase a home. At this phase, a mortgage loan originator (MLO) or bank loan officer discusses the borrower's financial circumstances regarding income, debt, and the amount of money available for a down payment. They try to match the borrower with suitable home loan products.

intention to proceed with the loan

borrowers indicate their intention to proceed with the transaction by communicating that intention to the lender or mortgage loan originator. The communication can be made in person, over the phone, via email, or by signing a pre-printed form after receipt of the Loan Estimate. However, a borrower's silence does not indicate an intention to proceed. Once the borrower has the Loan Estimate and agrees to proceed with the loan, the next phase—loan processing—may begin.