California Real Estate Practice Chapter 9 Rockwell Slides

Audited Financial Statement

A financial statement summarizes his financial condition by itemizing all his assets and liabilities.

Financing Disclosures: Licensee acting as mortgage broker

In California, licensed real estate brokers and salespeople are permitted to negotiate mortgage loans for compensation. You may find yourself handling the financing arrangements for buyers you represent. If you do negotiate any mortgage loans, you are required to make certain disclosures to the borrower. If you negotiate a mortgage loan, you must make disclosures to borrower.

#3. Income: Verifying income

1) Lender verification 2)Applicant documentation A loan applicant fills in her income information on the loan application, but the lender can't simply take the applicant's word about her income. The lender needs to verify the information provided on the application. A lender will verify all of the income information a loan applicant provides, by contacting the applicant's employer and examining other financial records. There are two main methods of verifying employment income. In the first method, the lender verifies the information independently. In the second method, the applicant provides the necessary documentation. In the first method of verification, the lender sends an income verification form directly to the applicant's employer. The employer will fill out the form and then send it directly back to the lender. The applicant is not supposed to handle the verification form at all. 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. Other types of income must also be verified. Commission income is verified with copies of the applicant's federal income tax returns for the previous two years. Self-employment income is verified with audited financial statements and federal income tax returns for the previous two years. Alimony or child support is verified with a copy of the court decree and proof—such as bank statements or photocopies of the deposited checks—that the payments have actually been received. Rental income is verified with recent income tax returns; copies of current leases may also be required.

Acceptable Income: Unacceptable types of income

1) Unemployment 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. 1-Now let's take a look at the types of income that are usually not acceptable to a lender, either because they are not reliable or because they are not durable. For instance, as we mentioned earlier, unemployment benefits are designed to last only a short time, so they do not qualify as stable monthly income. 2-The earnings of family members other than the applicant spouses—for instance, the applicant's children or parents—are not ordinarily acceptable. This is because other family members are not obligated on the loan and are free to move out of the home at any time. Let's look at an example. Suppose the applicants have two children in their early 20s living with them. The wife's elderly father is also living with them. Both children work, and the wife's father has a pension. However, the lender will not take their income into account. Only the applicants—the husband and wife—are obligated to pay back the loan, so only their earnings matter in the lender's risk analysis. 3-Income from temporary employment—either part-time or full-time—is also not acceptable. A temporary job is simply not durable enough for the income to be considered stable monthly income. Temporary jobs include both those that have termination dates and those that do not. For instance, suppose the applicant got a job filling phone-in catalog orders during the Christmas rush. The job began on November 15 and is to terminate on December 30. This is clearly a temporary job, and the income generated from it would not qualify as stable monthly income. Now suppose that the applicant got a job with a property management firm cleaning up damage caused by a recent flood. The job has no termination date; the applicant will simply work until the job is done. Even though there is no termination date, the job is still temporary in nature and the income from it would not be considered stable monthly income. Sometimes a person goes from one temporary job to the next, and is able in this way to have steady work all the time. In that case, a lender might be willing to view the temporary income as self-employment income and count it as stable monthly income. -Long-term temporary employment might be considered acceptable self-employment income. For instance, suppose the loan applicant works in the computer industry as a temporary employee. He goes from job to job helping set up databases. Even though each job is a temporary job, he has worked continuously for the past four years doing this kind of work. A lender would probably consider this applicant to be self-employed and would consider his income to be stable monthly income. To review our discussion of acceptable and unacceptable income, let's look at the Monroe family. Mr. Monroe has been self-employed as a roofer for the last 12 years. Last year, he earned $70,000 in this capacity. Mrs. Monroe was recently laid off from a permanent position and has been performing temporary work for the equivalent of $20,000 per year. Mr. Monroe's father lives with the family, and he earns $31,000 per year in stable pension benefits and social security. Mr. Monroe's sister is also temporarily living in the house; she earns $42,000 per year as a legal secretary. If Mr. and Mrs. Monroe applied for a loan, how much annual income would the lender count in qualifying them for a loan? Only Mr. Monroe's income of $70,000 would be considered acceptable. Although he is self-employed, he has been in business long enough for his income to be stable. Mrs. Monroe's income would not be acceptable because it is temporary and therefore not durable. And although the other two incomes can be reasonably expected to continue, neither the father nor the sister is a loan applicant, so their incomes cannot be counted.

The Underwriting Process: Income

A lender never wants to lend a borrower more than the borrower can afford to repay. 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. No matter how good a loan applicant's credit history is, if she doesn't have enough income to make the mortgage payment, the lender is simply not going to make the loan. 1. How much stable monthly income? 2. Is the stable monthly income enough? In looking at a loan applicant's income, a lender goes through a two-step process. First, the lender must determine how much stable monthly income the applicant has. Then the lender must decide if the applicant has enough stable monthly income to make the mortgage payments required for the proposed loan.

Nontraditional mortgage

A loan secured by a one- to four-unit residential property where the borrower defers repayment of principal or interest.

Credit Reputation: Derogatory information: 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.

Credit Reputation: Derogatory information: Foreclosures

A real estate foreclosure stays on the debtor's credit report for 7 years. For obvious reasons, mortgage lenders view a previous foreclosure as a serious matter.

Acceptable Income: Other sources

Acceptable Income: -Employment income -Pensions and social security -Alimony (spousal maintenance) -Child support -Public assistance Employment income is not the only type of income that can count as stable monthly income. Income from pensions and social security is also acceptable. Alimony, or spousal maintenance, is acceptable if the payments are reliable. If the applicant wants the lender to consider spousal maintenance payments as part of his or her income, the applicant will have to show the lender the court decree that orders the payments. The lender will investigate how long the applicant has received the payments, the financial status of the ex-spouse, and the applicant's ability to compel the ex-spouse to make the payments. Here's an example. A loan applicant is supposed to receive $700 a month in spousal maintenance payments. She can show the lender the court decree that orders her ex-spouse to make the payments. However, when the lender examines the applicant's records, it's clear that she has received the payments only sporadically, about once every three or four months. The applicant has taken no action to compel her ex-spouse to make the payments more regularly. The lender is unlikely to consider the spousal maintenance payments as part of the applicant's stable monthly income. Likewise, child support will be considered stable monthly income only if it is required by a court decree and there is proof of regular payment. There is an additional restriction on child support payments. The closer the child is to the age of majority (when the payments will stop), the less likely the lender is to include the child support as part of the loan applicant's stable monthly income. If the child is over the age of 15, the lender probably won't count the child support payments. Here's an example. The loan applicant gets court-ordered child support for his two daughters, aged 13 and 16. The applicant has received the payments every month for the past four years. However, the lender will count only the support payments for the 13-year-old when calculating the applicant's stable monthly income. The support payments for the 16-year-old will last for less than two years—not long enough to be considered stable monthly income. Another type of acceptable income is income from public assistance programs such as welfare or food stamps. The Equal Credit Opportunity Act prohibits lenders from discriminating against loan applicants because any of their income is from a public assistance program. If the public assistance payments are expected to continue for a sufficient period of time, the lender must consider the payments stable monthly income. However, if the payments will not last long—for example, because the applicant's eligibility will terminate soon—they will not count as stable monthly income.

Acceptable Income: Investment income

Acceptable Income: -Employment income -Pensions and social security -Alimony (spousal maintenance) -Child support -Public assistance -Investment income Income from investments, such as stock dividends or interest on a savings account, can also be considered stable monthly income. Of course, if the applicant has to sell the stock or use the money in the savings account to make his downpayment or to pay for closing costs, the income from those investments will not be considered part of his income.

Acceptable Income: Rental income

Acceptable Income: -Employment income -Pensions and social security -Alimony (spousal maintenance) -Child support -Public assistance -Investment income -Rental Income Net income from a loan applicant's rental properties will be accepted as stable monthly income, with some restrictions. First, the applicant must be able to prove that the rental payments are made regularly. Second, to account for maintenance expenses, possible vacancies, and uncollected rents, the lender is likely to include only a portion of the rental payments as stable monthly income. For example, suppose the applicant owns a rental house and charges $1,000 a month in rent. His records show that the tenant has paid this amount every month for the last few years. Even so, the lender will only include 75% of the monthly rental payment in the applicant's stable monthly income. This way, if the property ever requires major repairs, is vacant for a few months, or the tenant fails to pay the rent for a month or two, the loss in income will already be accounted for. 1) Payments are made regularly. 2) Lender deducts bad debt/vacancy factor. $1,000 x 0.75 =$750

Acceptable Income: Co-mortgagors

Acceptable Income: -Employment income -Pensions and social security -Alimony (spousal maintenance) -Child support -Public assistance -Investment income -Rental income -Co-mortgagor A lender may also be willing to use the income of a co-mortgagor in qualifying a loan applicant. A co-mortgagor signs the mortgage and note along with the primary borrower and has the same legal obligation to pay off the loan. Parents frequently act as co-mortgagors to help their children purchase their first home. Co-mortgagors help a loan application only if their income is enough to support both their own mortgage payment and the new mortgage payment.

Credit Reputation: Derogatory information: 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 7 years.

Net Worth: Reserves

Also, buyers are often required to have reserves left over after making the downpayment and paying their closing costs. Typically, the reserves must be enough to cover two or three mortgage payments. Reserves make the lender more confident that the buyer could handle a temporary financial emergency without defaulting on the loan. Bank of Springfield Monthly mortgage payment: $1,500 Minimum reserve requirement: $4,500 Thus, a significant net worth tells the lender that the buyers know how to manage money, have enough cash to close the transaction, and can weather a financial emergency without missing a loan payment.

Automated Underwriting System (AUS)

An AUS can analyze a borrower's loan application and credit report and provide a recommendation for or against approval. Though computer programs speed up the underwriting process, analyzing a loan application can't be entirely automatic. Generally, the final decision on whether to approve the loan is still made by human beings.

#4. The Underwriting Process: Net worth

An individual's net worth is his bottom line—what he's worth in dollars and cents. To calculate someone's net worth, you simply subtract his liabilities from his assets. Assets - Liabilities = Net worth 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. Suppose a loan applicant owns a house, a car, and some furniture, and has $2,000 in savings. The total value of these items is $177,000. She owes $5,000 on the car and $154,000 on the house; she owns the furniture free and clear. If you subtract the money she owes from the value of her assets, you can see that the applicant's net worth is $18,000. $177,000 Assets - $5,00 Car loan -$154,000 Mortgage = $18,000 Net worth

Prequalification

An informal process in which a real estate agent sits down with the buyers and asks questions about their income, assets, debts, and credit history. The agent uses this information to help determine what type of financing the buyers might qualify for. Although prequalifying buyers used to be common, most agents now simply recommend that their buyers get preapproved by a lender.

Credit Scores: How credit scores are used

An underwriter will use a loan applicant's credit score to determine what level of scrutiny to apply 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 more closely at the circumstances that caused the applicant's credit problems. In addition, a loan applicant's credit score may affect the interest rate that will be charged on the loan. If the credit score is mediocre, the lender might still approve the loan, but charge a higher interest rate to make up for the increased likelihood of default. Such a loan is sometimes called a subprime loan.

Licensee Acting as Mortgage Broker: RESPA's good faith estimate

Another type of disclosure is required if you negotiate a mortgage loan that is subject to the Real Estate Settlement Procedures Act (RESPA). RESPA is a federal law intended to provide home buyers with information about closing costs and help them shop around for settlement services. RESPA applies to most home purchase loans made by institutional lenders for one- to four-unit residential property. -Good Faith Estimate Under RESPA, a real estate broker acting as a mortgage broker must provide the borrower with a good faith estimate of closing costs. This estimate must be given to the borrower within 3 business days of receipt of the written loan application. If you negotiate a loan covered by RESPA, you are not required to provide the borrower with a mortgage loan disclosure statement and a separate good faith estimate. Instead, you would use a good faith estimate form that contains the required California disclosures.

Credit Reputation: Derogatory information: 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 10 years, rather 7 seven.

Net Worth: 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. A loan applicant is supposed to list her assets on the loan application, and the lender will do whatever it can to verify the information provided. Encourage your buyers to list all their assets. Point out that anything of financial value is an asset, including real estate, cars, furniture, jewelry, stocks, bonds, or the cash value in a life insurance policy.

Stable Monthly Income: Acceptable types of income

Because it would take a long time to judge the quality and durability of each source of every applicant's income, lenders have developed general rules of thumb for determining what is and what is not stable monthly income. Wages or a salary from permanent employment is usually a loan applicant's main source 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. First let's look at what is usually considered to be stable monthly income.

Credit Scores: How credit scores are used (2)

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 or discrepancies. (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. If the buyer finds any errors in his credit report, he should contact the credit agencies. A federal law called the 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.

Choosing a Loan: Other considerations

Buyers choosing a loan need to think about many other practical issues beyond interest rates and other loan costs. They need to consider how the loan will fit in with their overall financial picture. How much money will be left in savings after closing the transaction? How much money will be leftover each month after making the mortgage payment? A buyer who knows that he will have other significant expenses in upcoming years will probably want to choose a loan that minimizes his monthly payment amount. For instance, he might be planning to have children, to start a new business, or to direct more money into other types of investments. A buyer with these plans probably wouldn't want to be saddled with a big monthly mortgage payment even though he could qualify for one. So he wouldn't want to borrow the maximum that a lender would loan, and he would want to make a low monthly payment a priority in structuring the loan. On the other hand, some first-time buyers who have limited purchasing power, but who expect their incomes to increase, want to buy the most expensive house they can afford. Knowing alternative financing options can help buyers maximize their purchasing power and afford an ideal house that might otherwise be out of reach. Some of the options they could consider might be: -FHA or -VA financing, -a conventional loan with a high loan-to-value ratio, -an extra-long loan term, -an adjustable-rate mortgage, -secondary financing, or -a buydown. Buyers should also be encouraged to think about their financial plans in a long-term fashion, and decide how their home ownership plans fit into that scheme. For instance, a buyer with significant earning power who hopes to retire early might be interested in a loan with a shorter term, such as a 15-year or 20-year loan. This type of loan would require higher payments, which would mean that the buyer might have to purchase a less expensive house. However, the loan would be paid off much earlier, for substantial long-term savings. On the other hand, buyers who plan to live in a house only a few years before trading up or moving to a different city will be more concerned with minimizing the short-term costs, rather than the overall long-term cost. These buyers might be interested in an adjustable-rate mortgage. They could benefit from a low initial rate without worrying about how much it will go up in future decades. Ultimately, buyers must decide on what type of loan to choose based on their unique financial circumstances and goals. By understanding: -the interaction of the downpayment and other closing costs, -the loan term, -a fixed or adjustable interest rate, -the size of the monthly payment, and -other competing needs that buyers might have for their monthly income, you can help buyers locate a loan that meets their personal needs.

Fee packing

Charging interest rates, points, or other fees that far exceed market rates and aren't justified by the level of service provided.

Subprime loan

If the credit score is mediocre, the lender might still approve the loan, but charge a higher interest rate to make up for the increased likelihood of default.

Credit Reputation: Derogatory information

If your buyer's credit report shows a history of credit trouble, the loan application could be declined for that reason alone. The lender uses a personal credit report to check a loan applicant's credit reputation. A credit report reflects the applicant's credit reputation for the past 7 years and any bankruptcies within the past 10 years. Derogatory credit information includes: -slow payments, -debt consolidations, -collections, -repossessions, -foreclosures, -judgments, and -bankruptcies.

Income: Income ratios

Debt to income ratio: All monthly debt payments as a percentage of monthly income Housing expense to income ratio: Monthly PITI payment as a percentage of monthly income 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. After calculating how much stable monthly income a loan applicant has, the lender must determine how large a mortgage payment that monthly income will support. Remember, the lender is concerned not only about the quality of the applicant's income, but also about the quantity: Does the applicant earn enough income to make the monthly mortgage payment? Lenders use a relatively simple tool to determine whether a loan applicant's income is enough: maximum income ratios. These are limits a lender sets to make sure the applicant's proposed monthly mortgage payment and other debt payments don't exceed a certain percentage of his monthly income. The rationale behind income ratios is that if a borrower's mortgage payment and other monthly debt payments exceed a certain percentage of his monthly income, he may have a difficult time making ends meet. As a result, he might default on the mortgage. The lender wants to make sure that the borrower can make the mortgage payment and still have enough income left over for his other expenses, such as food, clothing, doctor bills, car payments, and other necessities. There are two types of income ratios: 1) the debt to income ratio and 2) the housing expense to income ratio. 1) A debt to income ratio measures the monthly mortgage payment plus any other regular installment debt payments against the monthly income. 2) A debt to income ratio measures the monthly mortgage payment plus any other regular installment debt payments against the monthly income. A housing expense to income ratio measures the monthly mortgage payment alone against the monthly income. When you are dealing with income ratios, you must understand that the monthly mortgage payment includes: -principal, -interest, -taxes, and -insurance. This is often abbreviated as PITI. An income ratio is expressed as a percentage. For instance, if your buyer's proposed mortgage payment (PITI) is $957 and her stable monthly income is $3,300, her housing expense to income ratio would be 29%. The mortgage payment equals 29% of her monthly income. $ 957 Mortgage payment ÷$3300 Monthly income = 0.29% Housing expense to incom ratio $3,300 Monthly income x 0.29 Housing expense to incom ratio =$957 Mortgage payment=Monthly income Each type of loan program has its own maximum income ratios. For instance, the maximum debt to income ratio for one type of loan might be 36%, while for another type it might be 43%. For now, here's a general example to show you how income ratios work. Henry is applying for a mortgage. His annual salary is $46,000. This year he made an extra $1,100 in overtime, but that has not been a regular part of his earnings pattern. For the last three years, Henry received an annual bonus of $600. Now calculate Henry's stable monthly income. Assume that his annual salary is acceptable income because he has a stable employment history. You cannot add the overtime; he has not received it regularly, so it would not be considered stable monthly income. However, he has received the annual bonuses for the past three years. So add $600 to his annual income. Now divide $46,600 by 12 to get a monthly figure. $46,600 divided by 12 is about $3,880. This is Henry's stable monthly income. $ 46,000 Annual salary $ X,XXX Overtime pay +$ 600 Annual Bonus =$46,600 Annual income ÷ 12 Months in year =$ 3,880 Monthly income Now it's time to apply an income ratio. Suppose that for the type of loan Henry wants, the lender won't allow a housing expense to income ratio over 28%. $3,880 times .28 (or 28%) equals $1,086. This is the maximum monthly housing expense that Henry would qualify for under the lender's housing expense to income ratio. $3,880 Monthly income x .28 Income ratio =$1,086 Maximum monthly housing expense to qualify

Predatory steering

Directing a buyer toward a more expensive loan (one with a higher interest rate or greater fees) than the buyer could otherwise obtain.

Stable Monthly Income: Durability

Durability refers to likelihood 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.

Loan flipping

Eating into a homeowner's equity by charging high fees on repeat refinances.

Subprime Lending

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. Subprime borrowers often have poor or limited credit histories. Subprime financing is also used by buyers who: can't meet standard income and asset documentation requirements; have good credit but carry a large amount of debt; or want to purchase nonstandard properties that regular lenders won't accept as collateral. -Low-documentation loan -Unusual property -High debt ratio In exchange for taking on more risk, subprime lenders typically charge significantly higher interest rates and fees. Subprime loans are also more likely to involve prepayment penalties, balloon payments, and negative amortization. Beginning in the late 1990s, a boom in subprime lending allowed many subprime borrowers to buy homes. However, many of these loans turned out to be poor risks, and large numbers of borrowers eventually defaulted. This foreclosure epidemic affected not just the mortgage industry but the economy as a whole. Subprime financing is now much less common.

Fair Credit Reporting Act

Federal law requiring 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.

Credit Reputation: Derogatory information: 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 already financially overextended, or it may indicate that she fails to take debt repayment seriously.

Credit Reputation: Derogatory information: 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 7 years.

Credit Reputation: Derogatory information: Judgements

If someone successfully sued the loan applicant, that will show up on the credit report. A judgment is listed on a credit report for 7 years after it is entered in the public record.

#6. Choosing a Loan

In many cases, a buyer will have a bewildering array of financing choices. She will have to choose between different lenders offering loans with different features and different costs. She will need to evaluate each of these possible loans, comparing not just the costs but also the short-term and long-term effects of how the loan is structured. Some of your buyers, especially first-time buyers, will ask you which lender they should apply to. While the decision will be the buyer's, you should be able to recommend two or three reputable lenders. You can also offer your buyer some tips on how to choose a lender. While interest rates are important, there are several other criteria your buyer should ask about. They include: -interest rates -the overall cost of the loan, -the APR, -the lender's lock-in policies, and -the lender's competence. Comparing loan costs can be tricky. The borrower must consider not just the quoted interest rate but the loan fees and financing charges as well.

Financing Disclosures: Seller Financing Disclosure Law

In seller financing, a seller helps finance the sale of her home by extending credit to the buyer. When seller financing is used for a one- to four-unit residential property, certain disclosures must be made to both the buyer and the seller under the Seller Financing Disclosure Law. *Disclosure statement -filled out by arranger of credit -must be provided before note is executed The disclosure statement is filled out by the arranger of credit. The arranger of credit is the person who negotiates the seller financing, which is usually the selling agent. The disclosure form must be delivered to the parties BEFORE any note is executed, and signed by the arranger of credit, the buyer, and the seller. Signed copies must be provided to the buyer and seller, and the arranger of credit must keep a copy on file for 3 years. The disclosure statement often takes the form of the Seller Financing Addendum and Disclosure form. This form is an addendum to the purchase agreement.

Income: Stable monthly income

It may seem that the only thing a lender should be concerned about is the quantity of the loan applicant's 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. Does he have enough monthly income to make the proposed monthly mortgage payments and still have enough money to meet his other expenses? And in fact, the lender is very concerned about how much income the applicant has. The lender doesn't want him to have to choose between paying the mortgage and paying for food and clothing. Analyzing Income: 1. Quantity 2. Quality 3. Durability But before the lender can judge whether the applicant makes enough income, the lender must first look at the quality and durability of his income. In other words, the lender does not treat all income the same. Some types of income are considered better than other types. And it is quality and durability that determine whether income is good enough to be considered stable monthly income.

The Underwriting Process: Financial management skills

Lenders feel that if a loan applicant has been able to accumulate a significant amount of net worth, that's a sign that he has good financial management skills and will probably be a good credit risk. 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. For example, Lewis has been out of college for three years. He makes $2,300 a month. His monthly bills consist of a revolving charge card payment of $35 and a college loan payment of $65. He owns his $8,000 car outright, has $3,200 in a retirement account, $1,000 in mutual funds, and $11,500 in a savings account set aside for a downpayment and closing costs. He's applied for a loan that has monthly payments of $695. The lender's maximum income ratios indicate that the biggest loan payment he can qualify for is $644. However, because Lewis has managed to accumulate a significant amount of assets in a short period of time, the lender might approve the loan anyway. Lewis's accumulation of assets shows that he's an able money manager, and that reduces the risk of making a loan to him. Monthly income: $2,300 Charge card payment: $35 Student loan payment: $65 $8,000 Car + $3,200 IRA + $1,000 Mutual funds +$11,500 Savings =$23,700 Net worth

#2.The Underwriting Process

Lenders use underwriting standards to evaluate a buyer's creditworthiness. To be helpful during the preapproval process, you need to understand the criteria that lenders use to evaluate potential borrowers. These criteria are known as qualifying standards or loan underwriting standards. Loan underwriting is the process a lender goes through to evaluate a mortgage loan applicant and the property she wants to buy, to determine whether the proposed loan is a good risk. With each mortgage loan a lender makes, the lender assumes two risks. The first risk is that the borrower will fail to repay the loan as agreed. The second risk is that, if the borrower does default, the security property will be worth less than the amount the borrower owes the lender. LENDER'S RISKS: Borrower might default Property might not provide adequate security for loan These two risks are always present, but lenders try to reduce them as much as possible by using underwriting standards to weed out the riskier loan applicants. If a loan applicant can't meet the lender's underwriting standards, the loan will be considered too risky and the application will be rejected. LENDER'S RISKS: Reduced by using underwriting standards The lender applies underwriting standards to both the loan applicant and the property. The lender evaluates the property based on an appraisal that is ordered as part of the loan application process. You'll find that the techniques used in appraisal are very similar to, but more rigorous than, the techniques used in competitive market analysis. A lender can apply its own underwriting standards to qualify a loan applicant. For the most part, however, lenders use uniform underwriting standards established by the major secondary market agencies, Fannie Mae and Freddie Mac. If the lender doesn't apply the uniform standards, the loan is considered nonconforming, and the lender won't necessarily be able to sell it on the secondary market. Whether or not a lender uses the uniform standards or its own rules, the underwriting process itself—the steps the lender takes to evaluate a mortgage loan applicant—is almost always the same. It is that basic process that you will be learning about today. To qualify a loan applicant, the lender examines all of the information included in the loan application, plus additional information acquired from a credit report and verification forms. The lender uses this information to evaluate the applicant's complete financial situation. Nowadays, of course, lenders handle most of their underwriting process by computer. Fannie Mae and Freddie Mac each have an automated underwriting system (AUS) that lenders can use for loans they're planning to sell on the secondary market. An AUS can analyze a borrower's loan application and credit report and provide a recommendation for or against approval. Though computer programs speed up the underwriting process, analyzing a loan application can't be entirely automatic. Generally, the final decision on whether to approve the loan is still made by human beings. Dozens of factors have an impact on the loan applicant's creditworthiness. All of these factors pertain to three distinct elements of creditworthiness: income, net worth, and credit reputation.

Gift letter

Letter from relative stating that the money is a girft and does not have to be repaid.

Assets: Liquid assets

Liquid assets generally are more important to a lender than non-liquid assets. Liquid assets include cash and any other assets that can be quickly converted to cash. For example, stocks that can be easily sold are preferred over real estate. And lenders always like cash in the bank best of all.

Choosing a Loan: Loan costs

Loan Fees: -Origination fee -Discount points Borrowing money is expensive. Not only do borrowers have to pay the lender interest on the money borrowed, they also have to pay loan fees. There will be a loan origination fee and there may also be discount points. The loan origination fee pays for the administrative cost of processing the loan and typically ranges from 1% to 3% of the loan amount. Discount points increase the lender's yield or profit on the loan and range from 1% to 6% of the loan amount (one to six points). Lenders who quote low interest rates usually charge more points to compensate. A rough rule of thumb is that six discount points make up for a 1% reduction in the interest rate. Obviously, the loan fees add up. For instance, if your buyer is applying for a $150,000 loan and the lender is charging a 2% origination fee and four discount points, the buyer will pay a total of 6% of the loan amount, or $9,000, to get the loan. The variation in loan fees from one lender to another, and from one loan to another, makes it difficult to accurately compare loan costs. For example, one lender is willing to make a mortgage loan at 7.5% interest with 3 points. Another lender is charging 7.25% interest and 4 points. Can you tell which loan will cost your buyer less? The loan at 7.25% with 4 points is a slightly better deal. But the average borrower can't tell this just by looking at the figures.

Choosing a Loan; Lender competence

Loan costs and lock-in policies are not the only elements to consider when picking out a lender. It doesn't matter how low the APR is or whether the interest rate is locked in if the sale falls apart at the last minute because the loan was not processed in a timely manner. That's why your buyer should also look for a lender that provides good service. Competent lenders will make sure that the loan process goes smoothly and that no costly errors are made. The easiest way to find a good lender is to ask other, more experienced real estate agents for their advice. Good lenders are familiar names in the real estate community.

Disregarding buyer's capacity to pay

Making a loan based only on the property's value, without considering whether the buyer will be able to afford the loan payments. Monthly payment: $1,350 Buyer's monthly income: $2,470

Balloon payment abuses

Making a low monthly payment loan that is either partially amortized or interest-only, without disclosing to a borrower that a large balloon payment is due later. When the balloon payment is due, borrowers will be left with the choice of foreclosure or having to make an expensive refinance.

Credit Scores: Explaining credit problems

Many times, a spotty credit reputation 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. Most people try to meet their credit obligations on time; when they don't, there's usually a reason—loss of a job, hospitalization, a prolonged illness, a death in the family, or a divorce. If two or three derogatory items show up on a buyer's credit report, see if they occurred during a specific period for a valid reason, and if the credit report before and after that time period is okay. When your buyer explains credit problems to a lender, it's a mistake to blame the problems on the creditors themselves. All too often, a lender hears excuses from borrowers who refuse to accept responsibility for their own actions. The lender's reaction is predictable: skepticism and rejection. The lender will reason that if your buyer won't take responsibility for his previous credit problems, he won't take responsibility for future ones either. Your buyer should go to the lender and explain the situation honestly. If his payments were late for several months because he was laid off, he should tell that to the lender. The lender is likely to be sympathetic, especially if your borrower can show that he's now steadily employed and paying his bills on time. So when you're dealing with a credit problem, don't just assume your buyer will be rejected. Most credit problems can be resolved with time, and it's a mistake to automatically think that someone can't qualify for a loan. Refer him to a lender and get an expert's opinion.

Fraud

Misrepresenting or concealing unfavorable loan terms or excessive fees, or using other fraudulent means (such as falsifying documents) to get a borrower to agree to a loan.

Credit Scores: Maintaining a good score

Note that the events of the previous 2 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. -Applying for too much credit can also hurt a person's credit score. Each time someone applies for a new loan or credit account, the creditor makes a "credit inquiry" that becomes a part of that person's credit history. Too many inquiries in the past year can be an indication that a loan applicant is becoming financially overextended. However, if a number of credit inquiries are made within a two-week period, it is customary for all of them to be treated as a single inquiry in calculating the credit score. In this situation, it's likely that the loan applicant was comparison-shopping for a mortgage or a car loan and filled out a number of applications to find out the best rate. Credit agencies try to avoid penalizing people for this.

Assets: Real estate

Often, a buyer is selling one home in order to buy another (usually more expensive) home. In that case, the buyer can use her net equity in her current home as a liquid asset. Net equity is the difference between the market value of the property and the sum of the liens against the property, plus the selling expenses. In other words, the buyer's net equity is the money she expects to get from selling her current home. Old home Net Equity: $100,000 New home Price: $300,000 To estimate the amount of equity your buyer can apply toward the new purchase, take the appraised value of her current home (or sales price if she already has a buyer), subtract the outstanding mortgage and any other liens, and then subtract the estimated selling costs. Selling costs are usually between 10% and 13% of the sales price. Appraised value - Liens - Selling costs = Equity For example, suppose a loan applicant's present home is worth $300,000, the current mortgage amount is $224,000, and the estimated selling expenses are $34,000. From $300,000, subtract the $224,000 mortgage and the $34,000 in selling expenses. The $42,000 that is left is the applicant's net equity, which can be applied to the purchase of the new home. $300,000 Current home worth -$224,000 Current mortgage - $34,000 Selling expenses = $42,000 Equity -Proof of sale is required Sometimes equity in other property is the primary source of the cash that will be used to buy the new property. In that case, the lender will probably require proof that the property has been sold and that your buyer has received the proceeds before it will make the new loan. -Swing loan may be necessary if property has not sold If the property will not sell in time for closing, the lender may be willing to arrange a swing loan (or bridge loan), which provides the cash necessary to close the purchase of the new home. When the old home sells, the swing loan will be paid off from the sale proceeds. -Use equity, not appraised value, even if buyer isn't planning to sell Some of your buyers may own real estate that they aren't planning to sell. The property could be: -a rental house, -a small apartment building, or -vacant land. In any event, the property is an asset that should be included in the loan application. Again, it is the equity in this other real estate that is important, not just the appraised value. If a buyer has little or no equity in the property, it will be more of a liability than an asset. For a buyer who has a complex portfolio of assets, an Audited Financial Statement may be the best way to explain his creditworthiness to the lender. A financial statement summarizes his financial condition by itemizing all his assets and liabilities.

Income: Calculating monthly income

Once the lender has verified the loan applicant's income, the next step is to calculate the 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. 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. 1) For hourly pay, multiply by 173.33 $ 17.50 Hourly pay x173.33 Multiplier =$3,033 Monthly income 2) For semi-monthly pay, multiply by 2 $ 2000 1 & 2 amount paid x 2 Paid twice a month =$4,000 Monthly income 3) For bi-weekly pay, multiply by 26 and then divide by 12 $ 1,900 Paid every 2 weeks x 26 Half of weeks in yr. =$49,400 Annual income ÷ 12 Number of months =$ 4,117 Monthly income

#1. Preapproval

Preapproval is a formal process where a buyer fills out a lender's loan application prior to 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 amount once the buyer has selected a house. It is much easier to work with preapproved buyers: you know they are serious about finding a house, you know the maximum loan amount they have qualified for, and you know the price range of homes you should be showing them. Preapproved buyers are less likely to suffer the frustration and distress of making an offer on a home only to have their loan application rejected. Here's an example. Suppose that you were working with the Harrisons, who are first-time buyers. They did not get preapproved before you began showing them houses. The Harrisons found a house that they really loved. They made a full-price offer for it, even though the purchase price was more than they had planned on spending. The sellers accepted their offer. Two weeks later the Harrisons learn that their loan application has been rejected, and the sale falls through. They are embarrassed and disappointed. Even though you encourage them to look at more affordable housing, they decide to put off their home search indefinitely. If these buyers had been preapproved, they would have known how much money they could borrow, and they would have realized that they simply couldn't afford a home in that price range. They might not have even looked at the home in the first place. Instead, they would have focused on homes in the price range they could afford. To get preapproved, a prospective buyer will select a lender and submit a loan application and supporting documentation. The process is essentially the same as if the buyer had already selected a house; the only difference is that there isn't property for the lender to appraise. That part of the process will not happen until after the buyer has agreed to purchase a specific property. The lender will analyze the buyer's credit history, income, and net worth. If the buyer is creditworthy, the lender will issue a preapproval letter. This letter states that the lender will lend the buyer up to a certain amount toward the purchase of a home, assuming that the property meets the lender's standards. The letter is typically valid for only a specified period, such as one or two months, since changes in interest rates may affect how much the buyer can afford. If the buyer is still house hunting at the end of that period, the lender may agree to an extension. Preapproval streamlines the closing process. Because the buyer has already gone through the loan application process, the only steps that remain to be taken care of once the buyer has agreed to purchase a property are the appraisal and ordering a title report. A preapproved buyer is not only easier to work with, but is also more attractive to sellers. Suppose a seller is presented with two very similar offers, but only one buyer has been preapproved. The seller is more likely to accept the offer from the preapproved buyer. The preapproved buyer is more likely to get the financing necessary to complete the sale. In fact, in an active market, a listing agent might suggest to sellers that they consider offers only from preapproved buyers. If a buyer knows that she is ready to buy, getting preapproved can be a wise decision. One potential drawback to preapproval is that the preapproval letter may betray to a seller just how much the buyer could spend. For instance, suppose a buyer is looking at a house listed at $330,000, but he wants to make an offer of $300,000. The buyer's preapproval letter indicates he could afford a $360,000 house, so the seller knows that the buyer could afford to offer the full listing price. In that case, the seller might respond with a higher counteroffer than she otherwise would. One way of avoiding this situation would be to ask the lender to issue a special preapproval letter for this particular transaction, simply stating that the buyer is approved to purchase a $330,000 house. Until recently, some buyers used prequalification instead of (or in addition to) preapproval. Prequalifying is an informal process in which a real estate agent sits down with the buyers and asks questions about their income, assets, debts, and credit history. The agent uses this information to help determine what type of financing the buyers might qualify for. Although prequalifying buyers used to be common, most agents now simply recommend that their buyers get preapproved by a lender.

Predatory Lending: California Predatory Lending Law

Predatory lending is often associated with subprime mortgages, and contributed to the subprime mortgage crisis. California and other states have enacted statutes intended to help prevent predatory lending. California's Predatory Lending Law applies to purchase loans and home equity loans secured by residential property with no more than four dwelling units. The law prohibits various predatory lending practices. The property must be the applicant's principal residence. This law applies only to high-cost loans. For instance, it applies to a loan if the total points and fees exceed 6% of the loan amount. Also, the law is intended to help low- and moderate-income home buyers; it does not apply to jumbo-sized loans. Here are some prohibitions and requirements for loans covered by this law: -loan applicants can't be steered to a subprime loan if they qualify for a standard (cheaper) loan, -loan applicants must be given a disclosure statement entitled Consumer Caution and Home Ownership Counseling Notice, -the loan agreement can't include an acceleration clause that lets the lender accelerate the loan even if the borrower hasn't defaulted, -a prepayment penalty can't be charged if the loan is accelerated due to default, and refinancing isn't allowed unless it clearly benefits the consumer. The Department of Financial Institutions enforces the state's predatory lending law for certain types of lenders. The Department of Corporations does so for other lenders and for mortgage brokers. The Department of Real Estate is the enforcement agency for real estate agents. Anyone who knowingly violates the law may be fined up to $25,000 per violation, and must pay damages to the consumer. Additionally, a real estate agent who participates in a predatory lending scheme may lose his license and suffer other disciplinary action. *Violation -Enforced by various agencies -Fine of up to $25,000 -Loss of license possible

Stable Monthly Income: Quality

Quality refers to reliability Income quality refers to the reliability or dependability of the source. Stable monthly income is income from a reasonably reliable source. Thus, a loan applicant's income should come from a dependable source, such as an established employer or a government agency. The less dependable the source of the income, the lower the quality of the income. For example, if your buyer's only source of income is a job with a new construction company that is struggling to make ends meet, the lender may not consider this income very dependable. On the other hand, if your buyer has a job with the U.S. Post Office, the lender is likely to consider this income quite dependable.

Subprime mortgages

Riskier loans made by lenders that use more flexible underwriting standards.

Acceptable Income: Secondary employment income

STABLE MONTHLY INCOME Four years of commissions Three years of bonuses Aside from his primary employment income—regular wages or a base salary—a loan applicant may have other income from employment. In some cases these secondary types of employment income can be used to qualify for a loan. For instance, a lender may be willing to count bonuses, commissions, and part-time earnings if they are an established part of the applicant's earnings history. For example, suppose the applicant is a salesperson for a packaging company. In addition to his base pay, he has made between $1,500 and $2,000 a month in commissions for the last four years. He has also made around $5,000 in bonuses for the last three years. Since they have been a part of the applicant's earnings pattern for more than two years, the lender will accept the commissions and bonuses as part of his stable monthly income. If he had only been receiving commissions and bonuses during the past year, the lender probably would not have counted them. Overtime pay is usually not considered stable income. However, if overtime is clearly a regular part of the applicant's earnings, it may be accepted. For example, if the applicant has earned $500 a month in overtime for the previous three months, the lender won't consider it stable income. But if he has earned $500 a month in overtime for three months out of every year for the past four years, the lender may consider it stable income. Let's look at another example involving secondary types of employment income. Lydia is a commissioned salesperson for a pharmaceutical firm. She makes an annual base salary of $32,000. Last year, she made an additional $15,000 in commissions. She has made at least $15,000 in commissions for each of the previous five years. Last year, she was named "Salesperson of the Year" and received a $10,000 bonus. This was the first time she won such an award. Additionally, Lydia has started a small business, selling her handmade windchimes online. She earned $2,400 from this last year, her first year in business. From a lender's point of view, how much stable income did Lydia have last year? $47,000.00 A lender would consider Lydia's base salary to be stable income. Her commissions would also count as stable income, because she has a proven track record of receiving them. Because this was the first year that she earned a bonus, that would not be considered stable income. And because her self-employment income comes from a hobbyist enterprise that is less than a year old, it is doubtful that a lender would consider it stable income.

Acceptable Income: Self-employment

Self-employment: Lenders are stricter about the two-year requirement Supporting Documents: Feasibility studies Pro forma financial statement Client list New contracts Tax records If a loan applicant is self-employed, the standards are a little stricter. Self-employment income is considered less durable and less reliable than income from a permanent job. So lenders are more reluctant to count self employment income as stable monthly income. The lender will probably be quite strict about the requirement of two years in the same line of work. If the applicant has been self-employed for less than two years, she will have a more difficult time qualifying for a loan. And if the applicant has been self-employed for less than one year, it will be even more difficult. An applicant who has been self-employed for a short time will have to show the lender that she has a history of employment in the same field and a reasonable chance of success on her own. Here's an example. Suppose the applicant worked for an interior design firm for seven years, then left and started her own company nine months ago. She has a long history of working in the same field. So she prepares feasibility studies and pro forma financial statements to convince the lender that there is an excellent chance that her company will succeed. She shows the lender her client list, which includes many long-term clients from her previous job. She provides a copy of a contract that she just signed with a new client that will guarantee her a substantial amount of work for the next six months. She can also show from her tax records that each month her income has increased. The lender decides that her documentation is persuasive enough and accepts her self-employment income as stable income.

Choosing a Loan: Lock-ins

Suppose your buyer has spent a lot of time seeking out a loan with a low APR. Then, when it's time to close the loan, the buyer is shocked to learn that the APR is significantly higher than the rate quoted when he applied for the loan. This could easily happen, unless the buyer arranges to have the interest rate locked in. 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. If the interest rate is not locked in, the lender can change the rate at any time. If market interest rates are at 7.75% when your buyer applies for a loan, and increase to 8.25% by the time the loan closes, the buyer will be charged 8.25% regardless of the rate the lender quoted earlier. And of course, when the interest rate increases, so does the buyer's proposed monthly payment. In fact, the monthly payment could increase so much that your buyer no longer qualifies for the loan at all. So when a lender quotes an interest rate, your buyer should ask whether the rate will be locked in, and for how long. Generally, the lock-in period should be longer than the time required to process the loan. It might range from 30 to 45 days. The buyer should ask the lender what will happen if rates decrease during the lock-in period. Some lenders will allow the buyer to take advantage of a lower interest rate, others will not. They will insist that the buyer pay the locked-in rate even though market rates have gone down. In that case, it doesn't make sense for the buyer to lock in the rate if it looks as though market rates may drop in the next several weeks. A lender will often charge a fee to lock in the interest rate. The fee is applied to the buyer's closing costs if the transaction goes through. If the transaction fails through no fault of the buyer, the fee is refunded.

Mortgage Loan Broker Law

The Mortgage Loan Broker Law requires an agent who negotiates a loan to make various disclosures to the borrower, including the principal amount, loan costs, and the balance that will be paid to the borrower. Limits the commissions and fees that a real estate agent or other mortgage loan broker may charge a borrower. These limits apply whenever an agent or loan broker arranges a loan for a one- to four-unit residential property that is: -a first deed of trust for less than $30,000, or -a junior deed of trust for less than $20,000.

Licensee Acting as Mortgage Broker: Mortgage loan disclosure statement

The first type of disclosure required when you negotiate a mortgage loan is a mortgage loan disclosure statement. This disclosure statement must contain the following information about the loan: - the principal amount; - estimated loan costs and expenses, including broker and lender fees and commissions, that will be deducted from the loan proceeds; - the estimated balance that will be paid to the borrower; - the loan interest rate and payment terms; - a notice to the borrower regarding mortgage loan risks; - any liens against the property and the order of their priority; - any prepayment penalty; - and the name and license number of the real estate broker negotiating the loan. Disclosure statement must be provided within 3 days. This statement must be given to the borrower within 3 business days after receiving the borrower's written loan application, or before the borrower becomes obligated on the loan, whichever is earlier. Both you and the borrower must sign the disclosure statement. A copy of the signed statement must be kept on file by you or your broker for at least 3 years. A slightly different disclosure statement is used for a "nontraditional" mortgage—that is, a loan secured by a one- to four-unit residential property where the borrower defers repayment of principal or interest. These mortgages include interest-only and negative amortization loans and present extra risks for borrowers. The disclosure statement warns of increased payment size, negative amortization, and/or higher fees. It also includes information about comparable "traditional" loans, such as 30-year fixed rate loans. The Mortgage Loan Broker Law also limits the commissions and fees that a real estate agent or other mortgage loan broker may charge a borrower. These limits apply whenever an agent or loan broker arranges a loan for a one- to four-unit residential property that is: -a first deed of trust for less than $30,000, or -a junior deed of trust for less than $20,000. For these loans, a loan broker's commission can't exceed: -for a first deed of trust: 5% of the principal if the loan term is less than 3 years, or 10% of the principal if the loan term is 3 years or more. -for a junior deed of trust: 5% of the principal if the loan term is less than 2 years, 10% of the principal if the loan term is at least 2 years but less than 3 years, or 15% of the principal if the loan term is 3 years or more. Most loans have other costs associated with them, such as appraisal and credit report fees. These loan costs may not exceed 5% of the loan amount, or $390, whichever is greater. They may never exceed $700 or exceed the actual costs. We'll conclude our discussion of the Mortgage Loan Broker Law by mentioning another rule imposed by the statute. The law places limits on balloon payments in connection with first deeds of trust under $30,000 or junior deeds of trust under $20,000. (Seller-financed transactions are exempt.) For these loans, a balloon payment is prohibited if the loan will be paid off in less than 3 years. If the property is owner-occupied, a balloon payment is prohibited if the loan will be paid off in less than six years. Any payment that's more than double the size of the smallest payment is considered a balloon payment.

Credit Reputation: 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. Today, 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 are designed to measure the likelihood that a particular person will default on a mortgage or other loan. A person with a low credit score is more likely to default than a person with a high credit score. 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.

Predatory Lending

The term predatory lending refers to mortgage practices that are used to take advantage of unsophisticated borrowers. Predatory lenders tend to target elderly or minority borrowers, especially those with limited income or limited English skills.

#5. The Underwriting Process: Credit reputation

The third part of the underwriting process is analyzing the loan applicant's 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. The lender does this by obtaining a credit report, and the applicant ordinarily pays the fee for the credit report. A personal credit report includes information about an individual's debts and repayment history for the preceding seven years. A typical credit report is shown on your screen. A credit report primarily covers credit cards and loans. Other bills, such as utility bills, usually aren't listed unless they were turned over to a collection agency.

Net Worth: Cash for closing

There are other reasons why lenders investigate a loan applicant's net worth. The lender also needs to make sure the applicant has enough cash to complete the purchase. That means enough cash to cover: -the downpayment, -the closing costs, and -the other incidental expenses of buying property.

Net Worth: Gift funds

There are times when a buyer has enough income to qualify for a loan, but lacks the liquid assets necessary to close the loan. In that case, his family may be willing to make up the deficit. This is generally allowed, as long as the money is a gift, not a loan. A gift of money from a relative must be confirmed with a "gift letter," which is signed by the donor. The letter should clearly state that the money is a gift and does not have to be repaid. Lenders often have their own forms for gift letters, and may require them to be used. -Spruce Bank requirements: Gift funds may not make up more than 50% of downpayment The lender will have to verify the gift funds, so the donor should give them to your buyer as soon as possible. It is best if the lender can verify the gift funds when it verifies the buyer's other bank deposits. In addition, most lenders place some limits on the amount of gift funds that can be used in a transaction. Lenders usually require borrowers to have at least some of their own funds invested in the property.

Preapproval letter

This letter states that the lender will lend the buyer up to a certain amount toward the purchase of a home, assuming that the property meets the lender's standards. The letter is typically valid for only a specified period, such as one or two months, since changes in interest rates may affect how much the buyer can afford. If the buyer is still house hunting at the end of that period, the lender may agree to an extension.

Net Worth: Liabilities

To determine net worth, liabilities are subtracted from assets. So after listing all her assets, a loan applicant must list all her liabilities. Liabilities include balances owing on -credit cards, -charge accounts, -student loans, -car loans, and -other installment debts -income tax -leins on real property Other debts, such as income tax that is currently payable, are also considered liabilities. If the loan applicant owns real estate, the remaining principal balance on the mortgage and the amount of any other liens are considered liabilities.

Request for Verification of Deposit" form

To verify a savings or checking deposit at the bank.

Loan Costs: Truth in Lending Act

Truth in Lending Act implemented through Regulation Z Comparing loan costs is made easier by the Truth in Lending Act (TILA). 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 3 business days after receiving the loan application. This federal law requires lenders to disclose the cost of their loans in the same manner, to enable borrowers to compare credit costs and shop around for the best effective rate. TILA is implemented through the Federal Reserve's Regulation Z. TILA and Regulation Z do not set limits on interest rates or other charges, but they do require that the costs be disclosed in a particular manner. Annual percentage rate 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. APR takes into account: -Interest -Points paid by borrower -Origination fee -Mortgage insurance or guaranty The most important disclosure required by TILA is the loan's annual percentage rate (or APR). The APR is the relationship of the total finance charges to the total amount financed. The total finance charges used in calculating the APR include interest, points paid by the borrower, the loan origination fee, and mortgage insurance or guaranty fees. To accurately compare the cost of two loans, a buyer should compare the APR of the loans. If the buyer simply compares the interest rates of the two loans instead, he will be misled. A lender may quote a low interest rate, but charge substantial loan fees, making the overall cost of the loan much higher than the quoted interest rate. The Truth in Lending Act requires that a lender give a loan applicant a disclosure statement presenting a good faith estimate of the financing charges. The lender must provide the disclosure statement within 3 business days after receiving the loan application. Most commonly, the disclosure statement is provided at the same time that the application is submitted. Although a buyer will not receive a disclosure statement before submitting a loan application, she can find out a loan's APR simply by asking the lender.

Acceptable Income: Permanent employment

Two years of continuous employment in same field The most common source of stable monthly income is income from permanent employment. For income from permanent employment to count, the loan applicant must have a history of continuous, stable employment. Generally, the applicant should have been continuously employed for at least two years in the same field. However, even without a two-year work history, there may be extenuating circumstances that would warrant loan approval. For example, the applicant may have recently finished college or just left the armed services. Any special education or training can make up for minor weaknesses in job history. Suppose the loan applicant is a school bus driver. If he has driven a bus for two years or more, his income will be considered stable. But if he has worked as a bus driver for only six months, the lender will want to know what he did before that. If his previous job history was stable and in a similar line of work, the lender will probably regard his income as stable. However, if he has a history of jumping from job to job, the lender might reject his loan application. Now suppose a loan applicant is working as an engineer, but she has been working for only the previous thirteen months. The reason for her short job history is that she just graduated from college. Because of her education and special training, the lender will probably consider her income stable in spite of her short employment history. Here's another point to keep in mind. If a loan applicant has changed jobs to advance within the same line of work, this is a good sign. For instance, suppose that an applicant changed jobs about two years ago, and again seven months ago. In each case, the new job represented a better position at a higher salary. Even though her job history shows two employment changes in a short period of time, a lender is likely to look at her job changes favorably. On the other hand, if the applicant has changed jobs persistently without any advancement, the lender will probably see this as a problem. If she changed jobs just for the sake of the change—there was no increase in salary or additional responsibility—the lender may worry about her job stability.

Other Financing Disclosures

We've seen how TILA requires lenders to disclose information about their rates and fees to loan applicants. Similarly, several federal and state laws sometimes require real estate agents to make certain financing disclosures to buyers and sellers. In this section, we'll take a brief look at these disclosure requirements.

Assets: Account verification

Your buyer should be ready to give the lender all the pertinent information about her bank accounts: -the name of the bank, -the account number, and -the balance. This information makes it easier for the lender to verify that the buyer has the cash on deposit that she claimed on her loan application. To verify a savings or checking deposit, the lender will use a "Request for Verification of Deposit" form. This form is sent directly to the bank and returned directly to the lender. A faster, alternative form of verification may be acceptable: -the loan applicant may submit original bank statements for the previous three months to verify sufficient cash for closing. The lender looks at four issues when it verifies deposits: 1) Does the verified information conform to the statements in the loan application? 2) Does the applicant have enough money in the bank to meet the expenses of purchasing the property? 3) Has the bank account been opened only recently (within the last couple of months)? 4) Is the present balance notably higher than the average balance? If the account was recently opened or has a higher than normal balance, the lender may become suspicious. These are strong indications that the loan applicant borrowed the funds to pay the downpayment and closing costs, and that is generally not allowed.