Loan Qualifying

A person's net worth is determined by subtracting her liabilities from her assets.

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Dozens of factors impact the loan applicant's creditworthiness. All of these factors fall into one of three categories: income, net worth, and credit reputation

-inome - net worth - credit reputation

financial management skills

A loan applicant who has accumulated significant net worth probably has good financial management skills. If the applicant's income is marginal—that is, his income ratios are a little too high to qualify for the loan—then an above-average net worth could mean the difference between approval and rejection of the loan

credit reputation

A loan applicant's credit reputation tells the lender about the applicant's ability and willingness to meet financial obligations. Derogatory information, such as late payments, debt consolidation, collections, or foreclosures, may indicate that the applicant is not creditworthy.

consolidations

A pattern of continually increasing liabilities and periodic "bailouts" through refinancing and debt consolidation is a red flag to lenders. It suggests that the loan applicant has a tendency to live beyond a prudent level

foreclosures

A real estate foreclosure stays on the debtor's credit report for seven years. For obvious reasons, mortgage lenders view a previous foreclosure as a serious matter.(Some alternatives to foreclosure, such as a short sale, will also tarnish a borrower's credit history.

collections

After several attempts to get a debtor to pay a bill, a frustrated creditor may turn the bill over to a collection agency. Collections show up on the debtor's credit report for seven years.

How credit scores are used

An underwriter uses a loan applicant's credit score to determine whether to apply further scrutiny to the applicant's credit reputation. If the applicant has a good credit score, the underwriter typically won't investigate further. Any derogatory information has already been taken into account in calculating the credit score. However, a mediocre credit score will prompt the underwriter to look at the circumstances that caused the applicant's credit problems.

bankruptcy

As you might expect, lenders look with disfavor on bankruptcies. There are three different types of bankruptcy: A Chapter 7 bankruptcy is a total discharge of debts. A Chapter 11 bankruptcy is a reorganization of a business. A Chapter 13 bankruptcy is a reorganization of personal finances. A bankruptcy appears on the debtor's credit report for ten years, rather than seven.

assets

Assets include cash, stocks, bonds, real estate, cars, and other types of property. Liquid assets are preferable. A lender will be concerned with the net equity held in real estate, rather than the appraised value of the property.

Obtaining credit information

Before a potential buyer begins the house-hunting process, it is a good idea for him to obtain a copy of his credit report and look for any errors. (Obtaining a copy of your own credit report does not count against you as a credit inquiry.) There are three major credit reporting agencies—Equifax, Experian, and TransUnion—and the buyer should obtain a report from all three of these sources. He should specifically ask for credit scores, which are not always included in a credit report.

Credit scores

Credit scores are one of the most important components of a loan applicant's credit reputation. Credit scores are based on statistical analysis of large samples of mortgage borrowers, and they measure the likelihood that a borrower will default on a mortgage or other loan. A person with a poor credit score is more likely to default than a person with a good credit score.

The lender looks at four issues when it verifies deposits:

Does the verified information conform to the statements in the loan application? Does the applicant have enough money in the bank to meet the expenses of purchasing the property? Has the bank account been opened only recently (within the last couple of months)? Is the present balance notably higher than the average balance

Subprime mortgages

Even if a buyer doesn't qualify for a loan under standard underwriting requirements, he might still be able to obtain a subprime mortgage. Subprime mortgages are riskier loans made by lenders that use more flexible underwriting standards.

A credit score that ranges from 300 to 850, where a higher score indicates greater creditworthiness.

FCIO score

Income ratios

Lenders set limits on the size of the applicant's proposed monthly mortgage payment and other debt payments using -Lenders and the secondary market have determined that if a borrower's mortgage payment and other monthly debt payments exceed a certain percentage of his monthly income, he will probably have trouble making ends meet and might default on the mortgage. The lender wants to be sure that the borrower can make the mortgage payment and still have money left over for food, clothing, doctor bills, car payments, and other necessities.

liabilities

Liabilities include balances on credit cards and charge cards, personal loans, mortgages, and other installment debts.

maintaining a good score

Note that credit problems in the last two years have the greatest impact on the applicant's score. The derogatory factors we discussed earlier—from late payments to bankruptcies—all take a toll on a person's credit score. In addition, other factors can have a negative impact on a credit score. For instance, if a person constantly carries a credit card balance that is near the maximum amount ("maxing out" the card), that will have a negative impact on his credit score even if he always makes the payments on time.

preapproval letter

Preapproval is a formal process in which a buyer fills out a lender's loan application before beginning the search for a house. The lender will issue a preapproval letter that commits the lender to loaning the buyer up to a specified maximum once the buyer has selected a house.

predatory lending

Predatory lending refers to certain lending practices used to take advantage of unsophisticated borrowers. Examples of predatory lending practices include predatory steering, fee packing, loan flipping, disregarding the borrower's ability to pay, balloon payment abuses, and fraud.

defrauding or misleading borrowers, lenders, or third parties; contracting with a borrower to receive fees even when the borrower doesn't actually obtain a loan; misrepresenting available rates, points, or financing terms; failing to make required disclosures to loan applicants and other parties; bribing an appraiser; advertising an interest rate without disclosing the APR (or otherwise violating the Truth in Lending Act); or a real estate licensee acting as a mortgage broker in the licensee's own transaction or a transaction handled by another licensee working for the same real estate broker (unless various rules are followed).

Prohibited practices include:

Age may raise the issue of durability in connection with this type of income.

Since child support payments usually end when the child turns 18, an underwriter probably won't count them as stable monthly income if the child is over 15.

acceptable income

Wages or a salary from permanent employment are usually a loan applicant's main sources of income. As a general rule, the applicant should have at least two years of continuous employment in the same field. Secondary sources of income may include commissions or bonuses, alimony or child support, public assistance, investment income, and rental income, if the income has been received reliably and can be expected to continue.

A lock-in requires the lender to adjust the rate downward for the benefit of the borrower if prevailing rates drop during the period between loan application and closing.

f - A lock-in usually maintains the same rate from the loan application until closing, even if rates drop rather than rise during that period. It does not make sense to request a lock-in if rates are expected to drop in the near future.

Matt and Jenny are recent college graduates who work entry-level jobs and live with their parents. If their parents are applying for a loan, the income of both the parents and their children will be considered.

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The Truth in Lending Act requires that the lender give the borrower a good faith estimate of all financing charges before accepting a loan application.

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There are two commonly used income ratios: the housing expense to income ratio and the maximum payment to income ratio.

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income verification form

in the first method of verification, the lender sends an income verification form to the applicant's employer. The employer fills out the form and sends it directly back to the lender. 2-In the second method of verification, the applicant gives the lender W-2 forms for the previous two years and payroll stubs or vouchers for the previous 30-day period. The lender confirms the information in these documents with a phone call to the employer.

durability

likelihood that income will continue -To count as stable monthly income, a source of income must also be durable—that is, expected to continue for a reasonable period of time. Examples of durable income include wages from permanent employment, permanent disability benefits, and interest on established investments. By contrast, unemployment benefits are an example of income that is not considered durable. Unemployment benefits, by their very nature, are not expected to continue for a long period of time. - two years of continuous employment in same field

To determine the quantity of stable monthly income,

the lender must first evaluate the quality and durability of the applicant's income.

A buyer who plans to live in a house for only a few years before trading up to a better house should consider an adjustable-rate mortgage.

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A buyer with a high income who is interested in early retirement may benefit from a loan with a shorter term.

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A mortgage lender may require a borrower to have cash reserves after making the downpayment and paying the closing costs.

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Bert is an efficiency consultant who is currently employed by the Glodo Corporation to streamline its shipping process. His employment will terminate once the project ends. Even though he is very well paid, this will be considered temporary and unacceptable income.

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The annual percentage rate of a loan takes interest, loan origination fees, discount points paid by the borrower, and private mortgage insurance into account.

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PITI

(principal, interest, taxes, and insurance).

unacceptable income

- unemp;loyment benefits 2. family members earnings 3. temporary employment Unemployment benefits, income from a temporary job, and income from persons who will not be co-signing the loan are all considered unacceptable income.

lock - ins

A lender may guarantee a loan applicant that a specific interest rate will be charged on the loan even if market interest rates go up during the period between the loan application and closing. The lender will customarily charge a fee to "lock in" the interest rate.

calcualtiong monthly income

A lender will always look at a mortgage loan applicant's income in terms of monthly income. Income received on any other basis will be converted to monthly income.

income verification

A lender will verify all of the income information a loan applicant provides, by contacting the applicant's employer and examining other financial records.

gift funds

If a loan applicant lacks the liquid assets to close a loan, a gift of money from the applicant's relatives may be used to make up the deficit. The gift must be confirmed with a gift letter stating that the money does not have to be repaid.

slow payments

If someone is chronically late in paying her bills, this will show up on the credit report. It may be a sign that she is financially strapped or that she fails to take debt repayment seriously.

repossessions

If someone purchases personal property on credit and fails to make the payments, the creditor may be able to repossess the purchased item. Repossessions show up on the debtor's credit report for seven years.

judgments

If someone successfully sued the loan applicant, that will show up on the credit report. A judgment is listed on a credit report for seven years after it is entered in the public record.

prequalification

In a prequalification, the buyer answers some basic questions about income, assets, and liabilities without providing documentation. The lender makes no commitment to lend, but the buyer gets a ballpark idea of what size loan she might qualify for.

income ratios

Income ratios are used to determine if the applicant has enough income to make the proposed loan payments. A lender may apply both a maximum housing expense to income ratio and a maximum debt to income ratio.

Regulation Z.

TILA is implemented through RZ . TILA and Regulation Z don't set limits on interest rates or other charges, but they do require that the costs be disclosed in a particular manner.

When a lender calculates a loan applicant's income ratios, the housing expense includes PITI.

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gift check must have letter that funds do not have to be paid back

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A buyer who wants to purchase the most expensive house she can possibly afford should be advised to seek out a 15-year loan for maximum purchasing power.

true-A 15-year loan will require a significantly larger monthly payment than a loan for the same amount over a long term. A buyer who wants maximum purchasing power should seek a loan with a long loan term, perhaps even a 40-year loan.

The purpose of TILA is the disclosure of all loan costs, to enable borrowers to shop around for the best effective rate.

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Riskier loan made using more flexible underwriting standards.

Subprime lenders make riskier loans, often in exchange for higher interest rates and fees.

Net worth is calculated by subtracting liabilities from assets. A substantial net worth shows that the loan applicant can manage money, has enough assets to close the transaction, and could weather a financial emergency if necessary.

net worth

One advantage of preapproval is that it helps determine the price range of houses that will be appropriate to show the buyers.

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The maximum loan amount is the maximum amount that a buyer may spend on a property.

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The most commonly used credit scoring model is the FICO model.

-You might also hear FICO scores referred to as Fair Isaac scores. FICO scores range from around 300 to 850. -A higher score (for instance, over 700) is interpreted as a sign of creditworthiness. -

income

A lender evaluating a loan applicant's income will first decide how much of his income counts as stable monthly income. The lender will then analyze whether the applicant has enough stable monthly income to make payments on the loan reliably.

stable monthly income

A lender is concerned with the quantity, quality, and durability of a loan applicant's income. Income that meets the tests of quality and durability is counted as stable monthly income.

truth in lending act

The Truth in Lending Act is a federal law that makes it easier for consumers to compare loans and shop around for the best possible rates. TILA requires a lender to give a loan applicant a disclosure statement with a good faith estimate of all finance charges within three business days after receiving the loan application.

credit report

The lender uses a personal credit report to check a loan applicant's credit reputation. A credit report reflects the applicant's credit history for the past seven years and any bankruptcies within the past ten years.

credit scores

The most important component of a loan applicant's credit reputation is her credit score. The score indicates the likelihood that the applicant will default on the loan, based on statistical analysis of large samples of loans. Credit scores may be affected by high credit balances and frequent credit inquiries as well as by slow payments and more serious credit problems.

Truth in Lending Act (TILA)

This federal law requires every lender to disclose the cost of their loans in the same way. Uniformity helps borrowers compare credit costs and select the best deal.

Mortgage Broker Practices Act (MBPA).

This law prohibits mortgage brokers from engaging in fraudulent lending practices.

calculation monthly income

You also should look at a buyer's income in monthly terms. Hourly wages can be changed into monthly income by multiplying the hourly wage by 173.33. -For example, if a buyer makes 17.50 an hour, multiply 17.50 by 173.33. The answer, $3,033, is the buyer's monthly income. -If a buyer gets paid twice a month, multiply the paycheck amount by two. -For example, if a buyer gets paid $2,000 twice a month, multiply 2,000 by 2. The answer, $4,000, is the buyer's monthly income. -If a buyer gets paid every two weeks, multiply the payment by 26 to get the annual income. Then divide the annual income by 12 to get the monthly income. For example, if a buyer gets paid $1,900 every two weeks, multiply 1,900 by 26. The answer, $49,400, is the buyer's annual income. -Divide the annual income by 12. The answer, $4,117, is the buyer's monthly income.

The most important disclosure under the Truth in Lending Act is of the loan's annual percentage rate, or APR. The APR expresses the relationship of the total finance charges to the total loan amount as a percentage.

annual percentage rate

net worth

assets - liabilites = net worth

A negative item that remains on a credit report for ten years.

bankruptcy

lenders risk

borrower default 2. property might not provide adequte security for loan

To count as stable monthly income, this type of compensation must be an established part of the loan applicant's earnings.

commissions

Refinancing and merger of personal debts.

consolidation

if a buyer's credit report shows a history of credit trouble, the loan application could be declined for that reason alone. Derogatory credit information includes slow payments, debt consolidations, collections, repossessions, foreclosures, judgments, and bankruptcies.

derogatory information

Income from unemployment benefits would not be considered to have this.

durability

appraised value - liens 0 selling costs

equity

Many times, a spotty credit history doesn't keep a buyer from getting a loan. If the credit problems can be explained and the lender believes the circumstances leading to the problems were temporary and no longer exist, the loan application might be approved.

explaining credit problems

A real estate agent may preapprove buyers.

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A seller is not likely to care whether or not a buyer has been preapproved.

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Marla is paid every two weeks. To determine her monthly income, a lender would multiply the amount of her paycheck by 24 and then divide it by 12.

false - to determine monthly income, her paycheck would be multiplied by 26 to determine her annual income (since she is paid every other week and there are 52 weeks in a year) and then divided by 12 (since there are 12 months in a year).

A house is currently appraised at $200,000. The owners owe $145,000 on the mortgage. If they were to sell the property, selling expenses would be approximately $20,000. Their net equity is about $75,000.

false- To calculate net equity, subtract selling expenses and the value of all encumbrances from the home's present value. In this case, the net equity would be $35,000 ($200,000 - $145,000 - $20,000 = $35,000).

In evaluating a loan applicant's net worth, a lender will generally prefer liquid assets such as real estate over non-liquid assets like stocks or bonds.

false-Lenders do prefer liquid assets, but real estate is not a liquid asset, since it may take months to sell. Stocks and bonds are liquid assets, since they can usually be sold very quickly.

A federal law that requires credit agencies to investigate complaints and correct errors.

he FCRA, or Fair Credit Reporting Act,

An underwriter typically counts only a specified percentage of this type of income as stable monthly income.

of rental income as stable monthly incom

If a buyer works for a newly founded company that is still struggling financially, a lender might be concerned that the buyer's income does not have this.

quality - Quality is a measure of the reliability of the payment of the buyer's salary or wages. An established employer is more reliable than a new enterprise.

quality

reliability - Income quality refers to the reliability or dependability of the source. Stable monthly income is income from a reasonably reliable source.

Seizure of items of personal property after the buyer defaults on payments.

repossession

Fair Credit Reporting Act

requires the agencies to investigate any complaints and correct errors. This process may take months, so it is best for buyers to investigate their credit well before they apply for financing.

For this to be considered an acceptable source of income, a loan applicant is generally required to have a two-year track record of success.

self- employment

Typically has poor or limited credit, or wants to purchase nonstandard or very expensive property.

subplime borrower