Chapter 7: Qualifying the Borrower
Sources of Income
*Bonuses, commissions, and part time earnings are considered durable if a borrower can show they've been a consistent part of earnings for at least one year, but preferably two or more. Proof of conisistency can be made with copies of W-2 forms, pay stubs, or federal income tax returns or the lender may send the employer a verification of employment earnings. *Overtime technically may count as part of a borrower's stable monthly income, but many underwriters are reluctant to rely on it because durability is uncertain. When qualifying buyers, don't count overtime earnings unless they are consistent *Disability payments count as income if they are a permanent source, but the lender will use caution if they are for a limited time. *Social Security will count if it is permanent income for a buyer who has reached retirement age. If these payments are the result of a disability or some other condition the lender will treat them like other disability payments. *Interest Yielding Investments are considered durable if the investments are sound and interest payments have been consistent. *Rental income can be counted if a stable pattern of positive cash flow can be verified. Cash flow is money available to an individual on a regular basis, after subtracting all expenses. Rents must cover all expenses and mortgage payments, while still leaving excess cash for owner. Authenticated copies of the owner's books showing gross earnings and operating expenses for the prior two years should be submitted along with a borrower's loan application.
Sources of Income (3 of 3)
*Unemployment and welfare are almost never treated as stable monthly income because they are viewed as temporary. However if a borrower can show an extended pattern of unemployment compensation received during a certain time (eg due to seasonal layoffs), the underwriter may consider it For Example: 1. Al has worked as a greens keeper at a golf course for 5 years. Every winter he is laid off receives unemployment, and receives a W-2 from the employment office. His unemployment income should be considered. 2. Brandon has a 6 year old son and receives aid for dependant children. This too should be considered. * Self employment income is documented by personal and corporate tax returns for the past two or three years that the borrower provides. (Remember, self employed means a person owns 25% or more of the business used for income qualifying.) The lender may also ask to see personal and corporate financial statements that show assets and liabilities for an individual (or an entity, such as a company) for a specific time period. Profit and loss statements and/or balance sheets may also be required. If a borrower has been self employed for less than 2 years, it will be difficult to qualify for a loan; and if the borrower has been in business for less than 1 year it will be even more difficult. Underwriters are wary of new businesses and are generally unwavering in their insistence that a self employed borrower must have operated the business profitably for at least 2 years.
Sources of Income (2 of 3)
*alimony, child support, and maintenance can be considered part of the borrower's stable monthly income if it is determined they are likely to be made on a consistent basis. Such a determination is dependent on whether the payments are required by written agreement or court decree, the length of time the payments have been received, the age of the child (child support payments generally stop at 18), the overall financial and credit status of the payer, and the ability of the borrower to compel payment if necessary (eg through a court order). A copy of the divorce decree is generally sufficient to establish the amount and enforce-ability of the required payments. In some instances the borrower may be asked to submit proof of receipt. Also the closer a child gets to age 18 the less durable child support income appears to a lender. There's no official cutoff date used by underwriters but most underwriters will see support payments as terminal and not include them in the stable monthly income figure, unless at lease 3 years remain before the payments cease. Note: Alimony, child support, and or maintenance do not need to be listed as sources of income if a borrower does not want them considered as income for the loan.
Consulting with the Lender (2 of 2)
After the buyer selects a lender, initial discussions usually involve the various types of mortgages offered by the lender (eg 30 year, 15 year fixed rate, ARM). This allows the buyer to decide which loan best suits his needs. A buyer will need to give the lender both personal and financial data in order to make the lending decision. Providing this info early will help speed up the approval process. When going for an actual loan approval (not a pre-approval), the purchase and sale agreements may be examined. The lender wants to see if compliance with the terms of the agreement is feasible. Of particular concern is the closing date. Often a contract will call for a closing date that's too early to be realistic. If it's impossible for the lender to meet the closing date a more feasible date can be agreed upon by all parties to the contract to avoid frustration. Loan fees must also be discussed. Best Practices: It is a good idea for an agent to consult the buyer's lender prior to writing the purchase agreement. The lender will be able to give helpful info regarding costs the buyer will incur and underwriting restrictions that may be encountered. Writing these into the offer in advance will eliminate surprises and addendums as the transaction progresses.
The Five C's
As the lender reviews the loan application and decides whether to make the loan, the borrower is evaluated on five criteria, referred to as the 5 C's: 1. Capacity- Does the borrower have the financial ability to pay the mortgage along with the other debts and obligations? 2. Collateral - Is the borrower's down payment and property value sufficient for the lender to recoup its money if foreclosure occurs? 3. Credit- Does the borrower's past payment history show a willingness and ability to repay obligations? 4. Character- Does the borrower have stability in a job and in responsibilities such that, even with setbacks financial obligations will be honored? 5. Conditions - Do other factors, such as economic health of borrower's job field, general economic conditions, etc., look favorable? The lender also wants to know the source of the buyer's down payment. Savings, sale of prior home, and gifts are all acceptable sources of down payment.
Automated Underwriting 1 of 2
Automated underwriting is a process whereby info from a loan applicant entered into a computer and an evaluation comes back within minutes advising the lender to accept the loan applicant, or refer the loan application for further review and analysis by a loan underwriter. The purpose of automated underwriting is to reduce the cost of examining a loan application and speed up mortgage approvals. A loan may be referred for review because automated underwriting systems are generally able to evaluate the first 3 Cs (capacity, collateral, credit), but the last two (character, conditions) are too subjective for a computer. The computer can evaluate the job and income data as being sufficient or insufficient to support the proposed mortgage payment and other debts. Next, the borrower's total equity position in the house is calculated based on the purchase price and proposed down payment. Finally, the computer determines the loan applicant's credit situation and likelihood of default based on the borrower's credit score and other risk factors. If any of these are marginal, the computer refers the loan applicant to a human underwriter to consider other factors. Automation is used in all facets of the lending process. Computers have helped the mortgage business become more efficient. And with large databases of statistics and info avail, the secondary market has increased efforts to manage credit risk by improving loan criteria. Automation will also determine and make recommendations as to the documentation required for a particular loan.
Common Fees Associated with Real Estate Loans 1 of 2
Buyers can expect to incur expenses for processing of the real estate loan application, including fees for: -pulling a credit bureau report -a property appraisal report -a preliminary title report -required inspections When a loan closes, additional expenses will apply, including title insurance and recording fees. Fees that occur only when a loan closes are likely to be paid out of the closing funds, but early expenses incurred by lenders must be paid, even if the loan doesn't close. This is when having a relationship with a lender can help because they may agree to absorb some of the smaller costs such as pulling a credit report. When no relationship exists a deposit ensures the lender that fees will be paid even if the loan doesn't close.
The Loan Application: Sections I and II
I. Type of Mortgage and Terms of Loan Details the mortgage option chosen II. Property Information and Purpose of Loan Location and legal description of the subject property, its value, and the manner of taking title. To determine how much security the property provides for the loan, lenders are interested in the current value and trend of the value, as well as any improvements that have or will be made. Lenders generally consider loans on a primary residence a better risk than those on a secondary residence or investment property. When money is tight lenders sense that most people will pay for their primary residence before spending money on other real estate loans. The lender also asks about the borrower;s source of down payment, settlement charges, and secondary financing as another means of ascertaining a borrower's financial stability.
The Loan Application: Sections III and IV
III. Borrower Info Personal info (eg name, address, phone number, social security number, age, schooling, marital status), including number of dependents (although children help stabilize a borrower, they add considerably to financial obligations). If less than two years at the present address, previous address info must be provided. A parallel section exists for co-borrowers. IV. Employment Info Current job including how many years in the same line of work; this demonstrates job stability. If less than 2 years at current job, previous employment info must be included. If self employed (owns 25% or more of the business used for income qualification), this must be noted on the application. Again there's a parallel section for the co-borrower's info.
The Loan Application: Sections IX and X
IX. Acknowledgement and Agreement. The borrower and co-borrower date and sign the application, acknowledging they have answered everything truthfully and understand and agree to be bound by the terms of the loan, if granted. X. Information for Government Monitoring Purposes This section is mandatory and is used by the government to monitory lender compliance with equal credit and equal housing laws. Remember the equal credit opportunity act (ECOA) prohibits discrimination in granting credit based on age, sex, race, marital status, color, religion, national origin, or receipt of public assistance. Note: A completely redesigned URLA (Fannie Mae Form 1003 / Freddie Mac Form 65) will be available starting July 1, 2019. The updated URLA supports changes in mortgage industry credit, underwriting, eligibility policies, and regulatory requirements. Its redesigned format is intended to be more efficient, to support accurate date collection, and to provide borrowers with a cleaner overall look and clearer instructions. Obsolete fields were eliminated, and new fields were introduced, including updated monitoring info under the Home Mortgage Disclosure (HMDA).
Completing the Loan Application 2 of 2
Info included on a loan app - new home purchase and sale agreement (not necessary for pre approvals, once the buyer finds a home, this can be supplied) Residence history (past two years) *landlord or rental agent's name, address, and phone number (if applicable) *current type of mortgage loan including the lender's name, phone number, and address (if applicable) Employment History (past two to three years) -name, address, and phone numbers of all employers -description of position held, employment status (full time, part time, temporary, etc.), and income earned -tax returns, including a year to date income and expense statement (if self employed or fully commissioned) - corporate tax returns (if major stockholder owning 25% or more in a corp's stock) Income Info - amount and source of income, including regular salary and secondary sources like pensions, social security, disability, child support, alimony, etc -documentation of income or verification of benefits from the income sources outlined above; child support and/or alimony require a copy of the divorce decree only if indicated as a source of income List Of Assets - balance, monthly payment, and account number for each creditor (along with name, address, and phone number) - copy of divorce decree (if paying child support or alimony) Copy of Gift Letter, if source of down payment or closing costs -letter must be signed by donor and state that the funds do not need to be repaid Certificate of Eligibility and DD-214 (Discharge Papers) - VA loans only Existing Home Sale Info (if applicable) - net amount of the sale (after commissions and expenses) -letter from the buyer's company stating what moving costs will be paid, if applicable Other relevant documentation or additional documentation requested by lender
Best Practices
Many lenders today will offer a pre-approval when what they are issuing is a pre-qualification. Be very careful to discern between the two or you may spend a lot of time and effort working with a buyer who may have hidden credit or loan problems. Read the pre-approval document from the lender carefully and if it is subject to things like "successful credit review", verification of income and debts," or "underwriting review," your buyers may actually be only pre-qualified. Ask questions to ensure the lender has done all the research necessary to successfully pre-approve the buyers and not just pre-qualify them.
Processing and Analyzing the Borrower and Property
Once the application is completed, the lender can begin gathering other pertinent info on the buyer. Many times, this is done by a person called a loan processor or just processor. This processor is a good source of info as to the status of the loan. Some lenders will accept a borrower's check stubs or W-2 forms, copies of bank statements, and other original documents; others still use verification forms sent to the buyer's employer, banks, other creditors, and previous mortgage lenders. A credit report will be ordered and a preliminary title report prepared. An approved appraiser will also be contacted to appraise the subject property. After examining the application, the lender may also ask the buyer to submit further info, such as: *investment account records, or other documentation *tax returns (if the buyer is self employed or living on investment income) *other documents relevant to a buyer's income or credit status
Common Fees Associated with Real Estate Loans (2 of 2)
Other more costly items such as property appraisal may have to be paid upfront by the borrower. For loans that close, lenders may also charge a loan origination fee (also called a loan service fee) to cover the administrative costs of making and servicing the loan. This fee is usually based on a percentage of the amount (1% equals 1 point) and paid out of the closing funds. RESPA requires lenders to provide a Loan Estimate that includes a good faith estimate of settlement costs no later than 3 business days following the date of a completed mortgage loan application. The Loan Estimate includes estimated closing costs, projected monthly payments, and the true cost of credit as an annual percentage rate.
Consulting with the Lender (1 of 2)
Potential borrowers can consult with lenders in a variety of ways, including in person or online. Before any steps are taken, it's important for the borrower to select the right lender. If a buyer already has a relationship with a lender this is a good place to start. On the other hand if a buyer has credit problems, it may be helpful to go through a mortgage company that deals with many different lenders. As buyers decide how to proceed with applying for a loan they may ask you for advice. To avoid confusion or problems remember these points: *do not interject your own opinion into the situation - let a credit professional, such as a lender, decide the buyers' credit situation *always let clients or customers have the final say as to how they apply for a loan and with whom *always consult with your broker regarding his policies in all areas before giving any type of advice or recommendation Remember it is the agent's job to educate the buyer about options- not to make the final decisions.
Underwriting and Approving the Loan Application
Processing the loan application involves reviewing the info submitted and verifying items as necessary. When the lender receives the credit report, verification forms, preliminary title report, and appraisal, a loan package is put together and given to an underwriter. An underwriter is the individual who evaluates a loan application to determine its risk level for a lender or investor and is usually the final decision maker on whether a loan is approved. The underwriting process can be automated (where all info is entered into a computer) or done by an individual who works for the lender. Both processes apply qualifying standards. With automated underwriting, computer software makes a recommendation to accept a loan, or refers it to a human underwriter for review. Loan underwriters carefully examine a loan package and decide to approve, reject, or approve the loan with conditions (eg., the buyer must bring proof that the previous home was sold and the mortgage is no longer outstanding).
The Art of Qualifying a Buyer 1 of 2
Qualifying a buyer simply means evaluating a borrower's credit worthiness. According to Fannie Mae, underwriting mortgage loans is an art not a science. Of course as automated underwriting becomes more widespread in the finance industry, it may seem as if the opposite of that statement is true. Still when the computer cannot approve a loan app, it is referred back to a human underwriter who goes through the traditional art of qualifying a buyer. And as a real estate agent it is helpful for you to understand this process. Two general steps all lenders take before agreeing to make a real estate loans are to evaluate the: 1. Borrower (to make sure he meets the minimum qualifying standards). 2. Property This evaluation process, loan underwriting, is where an underwriter evaluates various risk factors associated with a loan.
The Loan Applcation
The buyer(s) typically completes a loan application during the initial consultation with the lender. Lenders expect their loans to be repaid in a timely manner without collection, servicing, or foreclosure. Thus, employment stability, income potential, history of debt management, and net worth are important considerations made by the lender. The loan application details the borrower's financial and employment history and elicits responses to determine financial trends and attitudes in order to predict loan repayment. This explains why borrowers must supply so much information
Completing the Loan Application 1 of 2
The loan application is a required form that potential borrowers must complete, listing all pertinent info about the borrower and the subject property. Loan applications were designed for those who would follow through with the loan and actually borrow funds (upon loan approval), so a great deal of info is required. The same application is often used for pre-approvals, since the lender anticipates a pre-approval will eventually lead to a loan. If the buyer doesn't provide all of the necessary data during the initial consultation, it will be necessary to provide it later, which may delay the loan process.
The Art of Qualifying a Buyer 2 of 2
The primary concern throughout the loan underwriting process is determining the degree of risk a loan represents. The underwriter attempts to answer two fundamental questions: 1. Does the borrower's overall financial situation, which is comprised of income, credit history, and net worth, indicate he can reasonably be expected to make the proposed monthly loan payments in a timely manner? 2. Is there sufficient value in the property pledged as collateral to assure recovery of the loan amount in the event of default? Qualifying standards may vary from lender to lender, but with increased lender dependence on the national secondary market, a high degree of standardization in loan underwriting has developed. The majority of lenders throughout the country have incorporated the standards set by the major secondary market investors into their own conventional loan underwriting procedures, specifically Fannie Mae and Freddie Mac. Since most lenders use Fannie Mae and Freddie Mac conventional underwriting standards, it is important for real estate professionals to know those standards so they can expertly pre-qualify buyers and properties. Portfolio lenders make up their own rules since they hold the loan. Of course if the loan being contemplated is in conjunction with the FHA or VA, FHA, or VA underwriting standards must be used.
Pre-Qualification
The process of pre determining the loan amount a potential homebuyer may be eligible to borrow. An agent or a lender can pre qualify a buyer however it does not guarantee approval. Pre qualification of a buyer is not binding on the lender, which is why the distinction is very important. The lender is only saying it looks favorable that the buyer will be approved. Often there's more background research and info the lender has not thoroughly investigated and will not do so until a loan application has been submitted. Pre-qual is usually a simple process of asking the prospective buyer questions about income and debts. An in-file credit report (a quick and summarized credit report) may be pulled by a lender, or the buyer may be asked questions about his financial situation. A real estate agent's pre-qual of a prospective buyer may be as simple as making sure that the borrower has a steady job and no glaring credit problems (eg a recent bankruptcy). Often real estate agent will compute the buyer's income and debt ratios which we will discuss how this is done later to get an idea of how much house the prospective buyer may be able to afford.
The Loan Approval Process
The real estate loan approval process consists of four steps: 1. consult with the lender 2. complete the loan app 3. process the loan application 4. analyze the borrower and the subject property Traditionally, borrowers went to a lender's office for face to face meetings. Today, with busy schedules and a competitive environment, many lenders offer the option to meet with the borrower in their home or workplace. And of course the internet provides even more options. Many steps can be accomplished quickly and conveniently online or through other electronic means; from asking initial questions, filling out the loan application, getting final approval, and closing the loan.
Automated Underwriting 2 of 2
The two biggest automated underwriting tools used today are Freddie Mac's Loan Prospector and Fannie Mar's Desktop Underwriter. It is important to understand that automated underwriting tools and systems do not actually approve or reject loans. Instead the system is set up so the computer makes recommendations to the loan underwriter based on programmed risk factors. The desktop underwriter looks at 14 separate factors about the borrower and the property when evaluation the mortgage loan application. The three most important factors are: 1. equity in the property 2. credit history of the borrower (including credit score) 3. liquid reserves the borrower has in the bank Most systems only recommend approval or further evaluation of the loan application after examining additional documentation. In all cases the underwriter has the final say on behalf of the lender as to whether a loan is approved and the underwriter has ultimate responsibility for qualifying the buyer.
The Loan Application: Section VI
VI. Assets and Liabilities All assets and liabilities this used to determine the borrower;s net worth. Assets are items of value owned by the borrower, such as cash on hand, checking or savings accounts, stocks, bonds, insurance policies, real estate, retirement funds, automobiles, and personal property. Liabilities are financial obligations or debts owed by a borrower. Debts are recurring monetary obligations that cannot be cancelled. The distinction is that liabilities are money owed; debts specifically refer to recurring obligations (eg monthly bills). Note that any pledged assets, where collateral on another loan are considered liabilities up to the amount of money owed. A borrower must reveal alimony or child support as a liability if owed. Generally the lender will not consider debts with less than ten remaining payments (except leases, which always count regardless of how few payments remain). Still borrowers must list all debts including collections, slow pays, judgements, etc. Lenders will pull a credit report revealing these accounts anyway, so it is best to be honest from the start. Lenders may also use some debtors as credit references. Net worth is determined by subtracting liabilities from total assets. Most lenders feel a borrower;s net worth is a good indicator of creditworthiness. A high net worth shows an ability to manage money and may help offset other marginal items on an application. Further more, liquid assets that can be sold in an emergency to make payments give lenders additional security in making the loan.
The Loan Application: Sections VII and VIII
VII. Details of the Transaction Information on the real estate transaction itself - purchase price, prepaid items (eg escrows for taxes,insurance), estimated closing costs, mortgage insurance, etc. The borrower must also indicate secondary financing, seller paid closing costs, and any other credits, such as equity from selling the current home and deposits being held by a broker or title company. By adding and subtracting these amounts, along with the amount the borrower is financing, the lender can estimate the cash the borrower must bring the closing. VIII. Declarations. This section is basically a catchall. Here, the lender asks the borrower and co-borrower to declare by signing the acknowledgement and Agreement section, they they have had no outstanding judgments, bankruptcies, foreclosures, etc., which may not have shown up during the lender's research. The borrower and co-borrower must also declare whether they are obligated to pay alimony or child support, have borrowed any part of the down payment, are co-signers on any other debts, are U.S. citizens or permanent residents, and whether they intend to occupy the property as a primary residence.
Pre - Approval
the process by which a lender determines if potential borrowers can be financed, and for what amount of money. Real estate agents can't give a buyer a pre-approval. For pre-approval, a buyer goes through many steps in the loan process. Furthermore with pre-approval, a lender states that the prospective buyer's situation has been evaluated and providing all circumstances stay the same, the lender is willing to loan money (up to a specific amount) to the potential buyer. This is helpful when working with buyers and a powerful tool in getting an offer accepted by a seller. Of course a buyer's circumstances can and do change and pre-approval from some lenders means more than others. This is where familiarity of the loan process is important and where you should the advantage of the wisdom and experience your broker and other senior real estate professionals in your office can share. Above all else get pre-approvals from lenders in writing and always follow the policies and procedures established by your broker.
Fannie and Freddie: Housing Expense Ratio
A borrower's housing expense ratio is the relationship of the borrower's total monthly housing expense to income, expressed as a percentage: Total Housing Expense / Gross Monthly Income = Ratio % Conventional lenders consider a borrower's income adequate for a loan if the proposed total mortgage payment of principal, interest, taxes, and insurance (PITI) does not exceed 28% of stable monthly income. Stable monthly income is a borrower's monthly gross income that can be reasonably expected to continue in the future. This is usually a borrower's gross monthly income from primary employment and any other income considered reliable and likely to endure. For Example: Joe has 2.9k in stable gross monthly income. His proposed mortgage payment (PITI, plus private mortgage insurance) is $700. $700 / $2,900 = 0.24 = 24%
The Loan Application: Section V
V. Monthly Income and Combined Housing Expense Info Primary employment income, overtime, bonuses, commissions, dividends, interest, net rental income, and income from any other sources. Note that income derived from alimony or child support does not need to be disclosed, unless the borrower wants this considered as part of his income to qualify for a larger loan. Those who are self employed may need to supply additional supporting documents (eg personal tax reasons, corporate tax returns, financial statements). Monthly housing expenses (eg rent, mortgage payments, secondary financing, insurance, real estate taxes) are also requested here. The lender wants to know what the borrower is currently paying along with the proposed payment on the new mortgage. This helps gauge the extra burden for the new loan as compared to the current.
