|
Scientists
who study and measure human behavior find that buying a home is one of the most
stressful experiences of our lives. Contributing significantly to this anxiety
is waiting for the mortgage to be approved. Much of the homebuyers' unease
results from not knowing what is going on. You know credit checks and
verifications of employment are taking place-but what makes the difference
between getting or not getting that loan, and how long does it take? This page
can dispel at least some of that anxiety by detailing the steps the lender takes
in making the loan decision-process called "underwriting." Listed
below are the topics addressed on this page.
Just
as wise stock market investors carefully research the companies in which they
plan to buy stock, careful mortgage lenders investigate the financial background
of each loan applicant. In lending the prospective homebuyer the money to buy
the home, the lender assumes a long-term risk. The assumption is that the
borrower is going to eventually repay the loan and in the meantime make the loan
payments on time.
Once
all the information is collected and eligibility is established, the lender
decides whether to extend the homebuyer credit. In other words, lenders analyze
the risk of lending (making the investment), and match it to an appropriate
interest rate and loan term.
There
are no established, industry-wide standards for underwriting, though most
lenders follow standards set by government-related agencies, private mortgage
insurers, private mortgage investors or institutional investors. The vast
majority of mortgage lenders attempt to approve a loan application if at all
prudently possible, but to approve a loan that will become delinquent serves no
one's best interest. The burden falls on the lender to establish that an
applicant is qualified.
The
process usually begins with an interview where the prospective borrowers and a
representative of the lender sit down to discuss the potential loan.
Increasingly, however, lenders are not requiring a face-to-face meeting and
accept a completed application by mail. Many lenders today will even qualify you
for a loan before you begin to shop for a home. Many lenders advertise this
service in the local newspaper, but any lender can provide it. Knowing
approximately how much money you are qualified to borrow can save you time and
prevent disappointment when you are looking at houses.
When
going to see a lender for an initial interview, you should take:
- Purchase
contract for the house if you have one.
- Certificate
of Eligibility from the Veterans Administration (VA) if you want a VA loan.
(Note: If you do not have one, the lender will obtain the information for
you from your service records.
- Bank
account numbers and the address of your bank branch. This will save the
lender time in checking your credit.
- Credit
card bills for the past several billing periods.
- Pay
stubs, W2 forms or other proof of employment and salary.
- If
you are self-employed, you should be able to present balance sheets, tax
returns and other information about your business.
The
important document that gets the whole process rolling is the loan application.
It asks in-depth questions concerning you, your income, assets and liabilities,
your credit, and your legal history, as well as a description of the property
you wish to buy. The lender will verify the information you provide on the
application before making the decision whether to extend the loan.
Applicants
usually will know after the initial interview if they are qualified for the type
and size of loan they want. Lenders try to let the borrower know as quickly as
possible if they really are not qualified for the size of loan that they
request.
The
initial interview sets in motion some important consumer safeguards. The
Truth-in-Lending disclosure requirements provide the applicant with an estimated
yearly cost for the loan - the Annual Percentage Rate (APR). The other
important disclosure that follows from the Real Estate Settlement Procedures
Act (RESPA), a federal law. This requires lenders to provide homebuyers with
information on known and estimated closing costs.
The
initial interview also starts a clock that will allow applicants to know whether
or not they have been approved in about 30 to 60 days from the submission of a
completed application. If the loan is denied, the lender must disclose the
specific reason (s) for the rejection.
Following
the initial interview, or loan application, the first step the lender takes is
to verify your employment or income. This is done by mailing employment and
income forms to current and past employers, and it will help the lender
determine how much debt you can successfully take on.
A
general rule is that you can qualify for a loan of up to twice the family's
income (i.e. a family with income of $30,000 a year usually can qualify for a
mortgage of up to $60,000). Often, the amount you earn may not be as important
as how you earn it. Bonuses and commissions can vary greatly from year to year,
and lenders are reluctant to depend on them if they make up a large percentage
of your income. There are similar problems when a large portion of your salary
is based on overtime pay, and you rely on it to qualify for the loan. In the
case of bonuses and commissions, the lender will want to verify your bonus and
commission status back two or three years to get a better idea of what you earn
from those sources on average. In the case of overtime, the lender will
establish whether the work is expected to continue and whether or not the amount
of overtime income is reasonable for the extra work. After establishing these
points, the mortgage lender will make a decision as to how much to allow for
these additional sources of income.
If
you are self-employed, you should plan on producing a balance sheet, profit and
loss statements and copies of your federal income tax returns for the past two
or three years. Tax returns may also be required to verify other income claims,
such as when income from securities is a major source for mortgage payments.
Lenders
use a set of general standards (income/expense ratios which show how much income
is used for various expenses) to test the application for qualification. These
standards are based on what experience shows a homeowner can spend to own the
home and also take care of other long-term financial obligations, though lenders
use their own discretion in making the final decision.
Lenders
generally say that housing expenses (including mortgage payments, insurance,
taxes and special assessments) should not exceed 25 percent to 28 percent of the
homeowner's gross monthly income. For Federal Housing Administration (FHA)
loans, this figure is not to exceed 29 percent of the homebuyer's gross monthly
income. With loans guaranteed by the Department of Veteran's Affairs (VA),
lenders measure prospective homebuyers with Residual Income, or the
monthly income minus expenses. The remainder is then measured against
geographical and family size data to qualify the borrower.
Your
lender will work out these figures for you when you sit down to discuss the
mortgage you want.
-
- Housing
Expenses = 29% gross monthly income
- Housing
Expenses plus Long-Term Debt = 41% gross monthly income
Lenders
usually define long-term debt as monthly expenses extending more than 10 months
into the future. These expenses should not exceed 33 percent to 36 percent of
the homeowner's gross monthly income. FHA-insured mortgage lenders define
long-term debt as monthly expenses extending 12 months or more into the future,
and look for these expenses plus housing expenses not to exceed 41 percent of
the homeowner's gross monthly income.
Before
extending credit, lenders will want to examine the risk of not getting the money
back. To do this lenders will look at four crucial aspects of your credit
history when you apply for a mortgage:
- History
of past credit
- what were the size and terms of past loans?
- Type
of Credit - have you obtained real estate, auto, personal or other
installment loans in the past?
- Attitude
toward credit - are active accounts current , and is there any recent
bankruptcy or judgment?
- Lapses
in employment or debt repayment - how many unexplained lapses are there,
and for how long?
From
the information uncovered by these four questions, lenders can develop a fair
idea of just how you will handle your responsibilities once you have signed the
contract for repaying the loan. However, lenders cannot examine everything when
putting together a credit history. They have two extremely important limitations
on credit information gathering.
The
first limitation is the Fair Credit Reporting Act, which was designed to ensure
fair and accurate consumer credit reporting. The Fair Credit Reporting Act
stipulates that lenders must certify the purpose for which the information is
sought and use it for no other purpose. The Act also prohibits reports based on
subjective information from neighbors and others concerning character, general
reputation and other personal aspects. Certain other credit information, such as
bankruptcy more than seven years before, is also prohibited unless the principal
involved in the action was $50,000 or more.
The
second consumer safeguard limiting the credit information lenders can use to
make a mortgage decision is the Equal Credit Opportunity Act (ECOA). ECOA
prohibits discrimination in lending based on race, color, national origin, sex,
marital status, age (provided the applicant may legally contract), and the fact
that all or part of the applicant's income comes from a public assistance
program.
Lender's
are also prohibited by law from asking:
- questions
concerning the applicant's spouse, unless
- the
spouse will be contractually liable,
- the
spouse's income will be used to qualify,
- the
applicants live in a community property state, or
- the
applicant will use child support, alimony or separate maintenance
payments from a spouse or former spouse to qualify.
- questions
concerning future parenting plans (although the lender may ask the ages
and current number of children the applicant has).
Lenders
expect homebuyers to have enough money available to make the down payment of
between 10 and 20 percent of the asking price for the house-though FHA and VA
loans require smaller down payment (0 to 5 percent) and to pay their share of
the closing costs (3 percent to 6 percent of the loan amount). If, however, you
cannot come up with a 20 percent down payment, a lender can make you a loan for
as little as 5 percent down. He will, however, require you to carry private
mortgage insurance for conventional (not FHA or VA loans), for which you will
pay a premium for the first year and an additional monthly fee in subsequent
years.
Sources
on which prospective homebuyers may draw for the down payment and the closing
costs include savings, stocks/bonds, Individual Retirement Accounts (IRAs),
pension funds, real state holdings, life insurance policies, mutual funds or
employee savings plans.
Homebuyers
may also rely on another source of funding for the down payment-a gift, or money
given by a parent or other relative that need not be repaid. a person may give
another person up to $10,000 per year without either party being taxed. A
married couple, therefore, could give a child or spouse as much as $40,000 for a
down payment tax-free. Remember, however, that if you use gift money for a down
payment, you will need to present a letter so stating and signed by both the
giver(s) and the receiver( s) to your lender.
Mortgage
lenders send a form to the homebuyer's savings institution(s) to verify the
amount available for purchasing the house, as well as the amount of outstanding
loans with that institution.
Mortgage
lenders also examine the real estate being purchased to make sure that, in case
of foreclosure, the lender has a salable property. The property's acceptability
is established by an independent appraisal.
The
appraiser looks not only at what the home is worth today, but how the
neighborhood's dynamics will affect the property value in the future. The three
main points the appraiser checks are:
- Physical
security of the property.
- age,
structural soundness, landscaping, etc.
- Location.
- The
kind of neighborhood, surrounding houses, access to transportation,
commercial development nearby, etc.
- Local
government's plans for the area.
- how
zoning and taxes will affect the property in the years to come.
Your
lender has made all the checks. Your income, credit, assets, property and all
necessary documentation have been scrutinized. Now comes the big decision.
If
the lender's decision is to extend the credit, you will be notified, usually
through a commitment letter. The mortgage lender can approve the homebuyer for
the entire amount asked for, or a lesser amount based on the borrower's
qualifications. The commitment terms relating to interest rate and/or discount
points may be firm at the time of commitment or conditioned on the market rate
at the time of closing. If the decision is not to extend the credit, the lender
has 30 days from the acceptance of the completed application to notify the
prospective homebuyer. This notification must also include the reason(s) for the
rejection.
If
the loan is eligible for government insurance or guaranty, written agreements
stating so are issued. These can be either an FHA or Firm Commitment or VA
Certificate of Commitment. Conventional loans (not FHA or VA) receive an
application for private mortgage insurance if the down payment is less than 20
percent of the purchase price.
By
now you should feel a bit more at ease about what happens after you apply for a
mortgage. If you have a good credit rating, it will speak for itself. Also, it
is up to the lender to prevent homebuyers from over-extending themselves to the
point of losing their homes. Prudent underwriters should prevent this from
occurring.
Certainly
there will always be some anxiety associated with applying for a mortgage, but
if you understand the process, waiting for approval will be far less worrisome.
|
