Chapter 31: Loan Qualifying and Underwriting

The Loan Process

In most cases a real estate agent will be helping his or her client through the financing process. It is critical for agents to understand the process well enough to explain it to their clients, so that potential borrowers will know what is happening behind the scenes with their loan application. When a lender is processing a loan, there are four critical procedures involved. The lender or its designee must: 1. Determine the ability of the borrower to repay the loan. 2. Estimate the value of the property that is collateral for the loan. 3. Research and analyze the marketability of the title. 4. Prepare the documents necessary to approve the loan and close the transaction.

Stable Income

Income is considered stable if it comes from a consistent and reliable source. Depending on who the employer is, the income might hold a lot of weight or not so much. Income is also judged on its permanence - in other words, how long it can be expected to continue. Income that comes from permanent employment, government benefits, or some types of investment interest or dividends is favorably viewed. On the other hand, income from temporary employment or unemployment benefits is not considered stable enough for major consideration. There are some other guidelines that lenders use to determine if income is stable. It varies according to the type of employment. On the following pages, we'll discuss the various types of employment income, including how each influences the underwriter's evaluation of the borrower.

Encumbrance

Indicates that some other party has some rights or claims to the property. Examples are: 1. A utility right-of-way 2. Neighbor's fence or garage encroaching 3. Driveway easements through the property 4. Conditions, covenants, and restrictions (CC&Rs)

Assumption of an Existing Mortgage

An assumption of the mortgage obligates the buyer to assume liability for the debt. Both buyer and seller are equally liable in the event of default.

Lien

An indication of debt secured by the property. Examples are: 1. Outstanding property tax bills 2. Mortgage loans 3. Court-ordered judgements

Income

An underwriter must do a careful analysis of the borrowers' income to determine if, in fact, the borrowers can afford the monthly payment for the property they want to buy. When an underwriter is looking at an applicant's income, he/she must decide: 1. How much of the applicant's income is stable- income that isn't stable will not be used in the calculations for ability to repay the loan. 2. If the applicant has enough stable income to make the monthly payment.

Uniform Residential Loan Application- Section 9: Acknowledgement and Agreements

Both the borrower and the co-borrower must sign and date this section of the application.

Debt Ratio, or "Back-End" Ratio

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 43 percent.

Conditions, Covenants, and Restrictions (CC&Rs)

Define the use, requirements, and restrictions of a property. They are considered exceptions to the title because they buyer will receive a clear title except the conditions in the CC&Rs.

The Loan Estimate

Effective in October 2015, lenders are required to provide a document called a Loan Estimate to every borrower within three business days after receiving his or her application. The Loan Estimate is a three-page form that tells the borrower important details about the loan he or she has requested. The form provides the borrower with important information, including the estimated interest rate, monthly payment, and total closing costs for the loan. It also provides information about the estimated costs of taxes and insurance and how the interest rate and payments may change in the future. In addition, the form indicates if the loan has special features that the borrower needs to be aware of, like penalties for paying off the loan early (a prepayment penalty) or increases to the mortgage loan balance even if payments are made on time (negative amortization). If the loan has a negative amortization feature, it appears in the description of the loan product. The form uses clear language and design to help the borrower better understand the terms of the mortgage loan he or she has applied for. All lenders are required to use the same standard Loan Estimate form. This makes it easier for potential borrowers to compare mortgage loans so that they can choose the one that is right for them. When the borrower receives a Loan Estimate, the lender has not yet approved or denied the loan application. The Loan Estimate shows the borrower what loan terms the lender expects to offer if the borrower decides to move forward. When working with buyers, it's important for agents to help their clients understand what the Loan Estimate is telling them, especially if they have applied to more than one lender and have multiple Loan Estimate documents to compare. A borrower will not receive a Loan Estimate if he or she is applying for a reverse mortgage. For those loans, the borrower will receive two forms, a Good Faith Estimate (GFE) and an initial Truth in Lending disclosure. If the borrower is applying for a manufactured housing loan that is not secured by real estate or a loan through certain types of homebuyer assistance programs, the borrower will not receive a GFE or a Loan Estimate, but should receive a Truth in Lending disclosure.

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. If the borrower can convince the lender that any problems in the past were temporary and will not recur, the lender could well choose to approve the application. 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.

Sole Proprietorship, Partnership, or Corporation

If the applicant's income comes from a business entity, the lender will want to know how that business is organized. If the business is a sole proprietorship and the applicant is the owner, then the applicant controls the income and the self-employment guidelines we talked about earlier come into play. If the business is a partnership, there are others who have an income interest in the business. The applicant will not have full control of the income and its distribution. The vote of the stockholders controls a corporation's business income. If the applicant doesn't receive a salary or dividends, verifying income will be difficult.

Other Income

Often lenders will consider other forms of income as stable if they have been a regular part of the applicant's income for at least one to two years. This could be in the form of bonuses, commissions, or wages from a part-time job. Typically, overtime is NOT considered to be stable income, unless the applicant can prove that it has been regular and consistent for some period of time.

Sale of a Note

Once the mortgage document is in place, if the lender used the Fannie Mae/ Freddie Max uniform procedures, the lender can sell the loan in the secondary mortgage market. The third-party entity then becomes the new owner of the debt and the mortgage. When the debt is paid off, the new owner must execute the release of the mortgage. Many mortgages are NOT sold on the secondary market. These loans are called "portfolio loans" and are kept 'in house', meaning that the lender does NOT sell them on the secondary market, but keeps the loans. There are many circumstances where a portfolio loan is the best solution, either because of the property, or because of the borrower.

Marketable Title

One that is so free of defects that the buyer is certain he/she will not have to defend the title. In order to deliver a marketable title, the seller must have proof of ownership of the property, also known as evidence of title.

Uniform Residential Loan Application- Section 1: 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.

Uniform Residential Loan Application- Section 3: Borrower Information

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.

Uniform Residential Loan Application- Section 8: 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.

Novation

The exchange or substitution of a new debt for an existing debt my mutual agreement. If mortgaged property is sold, a lender may release the seller and create a new note with the buyer, who becomes the individual solely responsible for the debt. Unless there is a novation, the selling mortgagor will remain liable. A novation provides for the discharge of the original contract and creates a new agreement.

The Credit Report

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. Lenders typically assess how likely a borrower is to pay off his or her 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.

Qualifying the Buyer- Income Verification

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 typical form used to verify deposits is called the 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.

Uniform Residential 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. 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).

Cash

The mortgage may be paid in full from the sale proceeds, a satisfaction of mortgage recorded, and the property, delivered free and clear of the encumbrance at the time of closing.

Uniform Residential Loan Application- Section 6: Assets and Liabilities

1. 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. 2. 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.

Underwriting often works in the following way in most institutions:

1. For loan amounts up to Fannie Mae or similar maximum loan limits, the underwriter approves all loans submitted to the lender. 2. 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. 3. For jumbo loans, a loan committee must approve the file.

Making Payments on a Loan

1. Make payments on the note according to the agreement 2. Pay real estate property taxes 3. Maintain whatever level of insurance the lender requires 4. Keep the property repaired 5. Get the proper, required authorizations from the lender for any major changes to the property If the borrower fails to uphold his or her end of the agreement, he or she could be in default. Many mortgage documents have provisions for a grace period for a borrower to correct any problems. But if the grace period expires, the lender would have the right to foreclose on the property.

Credit Report Red Flags

1. The employment or residence data on the credit report is different from the application. 2. There are several recent inquiries from credit card companies or other mortgage lenders. 3. The Social Security number is invalid. 4. The length of the credit history is inconsistent with the borrower's age. 5. The co-borrower's maiden name is different from the data indicated on the application. 6. 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. 7. Late payments on the credit report due to unemployment, illness, or layoff do not match the Verification of Employment form data. 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.

Title Search Reveals:

1. The legal description of the property 2. The owners of record 3. Any outstanding liens or encumbrances on the property

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:

1. The market is open and competitive. 2. The property is exposed in the market for a reasonable period of time. 3. Both buyer and seller are fully aware of market conditions. 4. Both buyer and seller are acting with no undue pressure. 5. Buyer and seller are not related. 6. Both buyer and seller are aware of the property's potential for use. 7. Both parties are aware of the property's assets and defects. 8. The sale is a cash transaction. 9. The property has a marketable title. 10. The price does not include hidden aspects, such as service fees, credits, or special financing terms.

Some things that might "pop out" of the loan application include the following:

1. The new house being purchased is not large enough for all of the occupants. 2. The down payment is something other than cash. 3. The face value of a life insurance policy is shown as a liquid asset, but it is not a cash surrender policy. 4. The value of personal property is greater than one year's salary. 5. A high-income borrower has no personal property. 6. The new housing expense exceeds 150% of the current housing expense. 7. The salary amount seems inappropriate with respect to the amount of the loan. 8. Social Security number is invalid. 9. A high-income borrower has no credit and/or no cash. 10. A low-income or young borrower has a substantial amount of cash in the bank. 11. A high-income borrower has little or no cash in the bank. 12. A high-income borrower has furniture rental debt through a finance company. 13. A self-employed borrower has no business credit cards. 14. Information on the application is inconsistent with other loan documents. 15. There are significant changes or contradictions from a handwritten application to a typed application.

Some red flags that might appear when reviewing the Verification of Employmentform include the following:

1. There is an employment overlap between the current and previous employment. 2. There are no prior year's earnings. 3. All of the dollar amounts are rounded off. 4. The borrower was hired on a weekend or holiday. 5. Most of the income comes from commissions. 6. A prior employer is now out of business. 7. The borrower changed professions from the previous employer to the current employer. 8. The current business entity is not in good standing with regulatory agencies. 9. The verification form says the borrower has a company car, while the application shows the borrower has an automobile loan. 10. The income is out of line with the kind of employment. 11. 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:

1. There is not sufficient cash in the bank to close the loan. 2. The bank account is brand new. 3. The bank account is not in the borrower's name. 4. A gift letter is not backed up by any bank statements or canceled checks. 5. The borrower really has no bank accounts (says he doesn't believe in banks). 6. An IRA is shown as a liquid asset or as a source of the down payment. 7. There are significant changes in a balance from the prior two months to the day the verification is done. 8. There is an excessive balance in the borrower's checking account. 9. The date the verification was done by the bank is a weekend or holiday. 10. The checking accounts have an average two-month balance that is exactly equal to the present balance.

To sell the loan, the original lender:

1. signs the note over to a 3rd party investor or another mortgage company 2. executes a document called an assignment or mortgage

Installment Sale Contract

A contract for deed, or agreement for deed, is another method of buying real property, usually with very little cash investment. The seller accepts a down payment from the buyer and finances the rest of the purchase price. The significant feature of a contract for deed is that the title to the real property remains with the seller until the loan is repaid. The parties enter into a binding contract in which the seller contracts to deliver a deed at some future date, after a designated amount has been paid, and allows the buyer to take possession while paying the agreed-on payments. The buyer agrees to delay receiving title in his or her name until the required amount is paid to the seller. When the agreed amount is fully paid, the seller is obligated to transfer title to the buyer, at which time the buyer will assume the existing first mortgage (if any) or secure new financing.

Private Mortgage Insurance

As we discussed in the previous chapter, a Loan to Value Ratio which is less than 20% down (80% LTV), requires Private Mortgage Insurance (PMI). PMI is collected through a private insurer to cover the lender for any default on the part of the borrower. PMI is paid through the monthly property payment of Principal, Interest, Taxes, and Insurance (PITI), until a loan to original value ratio reaches 78% of the principal balance to that value. The lender or servicer is required to stop the PMI payments at the halfway point of a borrower's amortization schedule. For example, if the borrower has a 30-year loan, the midpoint would be after 15 years. The lender must cancel the PMI then — depending on whether the borrower has been current on their payments — even if the mortgage balance hasn't yet reached 78 percent of the home's original value. This is known as final termination. Removing PMI in this way works for folks with conventional mortgages who have paid according to their original payment schedules and have reached the milestones of 78 percent equity or the halfway point in time. To be eligible, the borrower must be up to date on their payments in order to automatically terminate PMI payments. A borrower may also request PMI cancellation when their mortgage balance reaches 80 percent. Instead of waiting for automatic cancellation, a borrower has the right to request that the servicer cancel PMI once the loan principal balance reaches 80 percent of the home's original value. If the borrower is making payments as scheduled, they can easily find the date that they will get to 80 percent on their PMI disclosure form (Loan Estimate or TRID page 1) or request it from their loan servicer. If a borrower has additional cash or makes additional payments on their principal, they may also reach an 80% LTV early by making additional mortgage payments. This method helps to build equity faster and saves on interest payments. Even $50 a month can make a dramatic drop in a loan balance and total interest paid over the term of the loan.

Income Ratio, or "Front-End" 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 FHA guidelines require the income ratio to be no more than 31 percent.

Property Issues

Fannie, Ginnie, and Freddie want properties which meet secondary market requirements, also known as "Fannie Mae guidelines". These include things like a central source of heat, a road to the property with an all-weather surface which will allow access to the property by emergency vehicles, an adequate kitchen for the preparation of food, a bathroom connected to a sewage disposal system, either public or private, a supply of potable water, and the property must be livable and have typical utilities. In some parts of Pennsylvania, agents sell second homes, also known as hunting camps and cabins which do not have good access (often the access roads are old logging roads, and not maintained during the winter), they may have only an outhouse, and they may not have electricity. These properties still have value and demand in the market, and they can be financed through the secondary market. The second category to make the use of a portfolio lender is a borrower who is not a 'cookie-cutter' borrower. They may be self-employed, their income could vary, but despite all of this, they may have a solid relationship with a local bank, which is often the bank they use for their business. Every real estate agent should be aware of who the lenders are in their area who offer portfolio loans, and establish good working relationships with them.

Real Estate Finance

Finance is the lending and borrowing of money. It is considered to be the core of the real estate industry. Often a real estate agent will need to help his or her client with the financing process. It is very important an agent to have a clear understanding of real estate finance.

Verifying Other Income

For income that does not come directly from an employer, the lender will use other verification methods. 1. The lender may require copies of federal income tax returns for the previous 2 years to verify income from commissions or self-employment. 2. Self-employed applicants may have to provide audited financial statements. 3. The lender may require copies of court orders to verify alimony or child support income and copies of bank statements to show the money was received and deposited. 4. Landlords may have to submit copies of their ledgers for their rental properties, along with tax returns showing the income.

Uniform Residential Loan Application- Section 5: 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.

Subject to the Mortgage

If the existing mortgage does not contain a due-on-sale clause, the mortgaged property may be purchased subject to the mortgage, where both the existing mortgage and note remain the obligation of the seller. The buyer is responsible for regular payments on the mortgage to retain possession. If the buyer defaults, the mortgagee can proceed to foreclose. If the foreclosure sale does not satisfy the mortgage debt, a deficiency judgment can be sought against the original mortgagor, who has remained responsible for the mortgage although the property was sold. A subject to purchaser does not become personally responsible for paying the debt.

Loan-to-Value Ratio (LTV)

Is the ratio of the mortgage principal to the value of the property the borrowers are purchasing. Let's say the buyers are purchasing a home for $120,000. They are making a $24,000 down payment and borrowing $96,000. The loan-to-value ratio in this scenario is 80%. The borrowers are making a 20% down payment and borrowing 80% of the home's value. If these same borrowers were making a $12,000 down payment on the same loan, the LTV would be 90%, since they would be making a 10% down payment and borrowing 90% of the home's value. As you can see, a higher LTV means a larger loan amount is being borrowed and a smaller down payment is being made. LTV may be based upon a purchase price but most often is based upon the appraised value for any bank. LTV may change after a certain amount of payments where the principal owed goes down, however the purchase price or appraisal price for the loan will not change. The difference between the purchase price/appraisal and principal balance, before or after payments, is called "Equity". Lenders use LTVs to determine a maximum amount to lend for a conventional loan. In some loan programs, the lender may set the maximum loan amount at 90% LTV, requiring the borrower to make a down payment of 10%, where other programs might allow a maximum of 95%, meaning the borrowers would only have to come up with 5% for the down payment.

The Underwriting Process

Once the borrower has submitted the loan application to the lender, the actual underwriting process begins. As we said earlier, 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.

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. 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.

Uniform Residential Loan Application- Section 4: Employment Information

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.

Uniform Residential Loan Application- Section 2: Property Information and Purpose of Loan

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.

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.

Closing the Loan

The closing of the loan usually happens at the same time as the closing of the real estate transaction. It entails the actual disbursement of the funds as outlined in the closing statements. Typically, by the date of the actual closing, the lender has already deposited the amount needed for the mortgage with the escrow agent, along with whatever instructions the lender has for how the funds are to be disbursed.

Underwriting

The evaluation process is used to determine the borrower's ability to repay a loan and estimating the value of the property being sued as collateral. 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. 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.

Uniform Residential Loan Application- Section 10: 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.

Assets and Liabilities

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. This could be especially important in a case where the buyer's income is not as good quality as the lender would like. Significant net worth could make the difference in whether or not the loan is approved. Some lenders require that applicants have a reserve of cash after the purchase is complete - enough to cover a few months mortgage payments in the event of a temporary financial crisis. It raises the lender's comfort level to know that the chances of a default during an emergency are greatly reduced with cash reserves. A buyer's net worth is determined simply by subtracting debts from assets.

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.

Request for Verification of Employment

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. On this form, the lender must complete items one through seven, 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. Alternatively, the lender could choose to collect W-2 forms and pay stubs from the applicant and then verify the information with the employer through a phone call.

Self-Employment

This has always been a complicated road to take. Reliable income from self-employment is hard to document unless the person has been self-employed for a number of years. Lenders have more stringent standards for the self-employed. Obtaining financing for an applicant who has been self-employed for less than two years is extremely difficult. It is usually only possible if the applicant has been employed in the same field for some time and can show through feasibility studies or market research that his or her business has a good chance of future success.

Permanent Employment

This is typically judged to be stable if the applicant has been employed continuously for two years or more in the same field. However, there are always extenuating circumstances, so each applicant's situation is carefully reviewed. If an applicant is a recent college graduate, for example, his or her lack of continuous employment could be given less weight. If an applicant has changed jobs a few times in the past few years, how the lender views this will be circumstance-dependent. If the changes were to advance in the same field, the lender will see this as favorable. But if the changes were from one company to another with no change in status, the lender might consider it a sign that the applicant has employment problems.

Uniform Residential Loan Application- Section 7: 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.

Underwriter's Job

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.

Calculating Payments

the borrower is responsible for making monthly payments that include both principal and interest. Most typically, the borrower has a flat monthly payment, part of which goes to interest and the rest to principal. So how does the lender determine how much to allocate to interest and how much to principal? In the case of amortized loans, the lender calculates an amortization schedule that is based on the amount of the loan, the term of the loan and the interest rate. The amortization calculation produces a monthly payment amount.