Chapter 8 Underwriting The Residential Mortgage Loan

Underwriting is an integral part of the mortgage lending process, regardless of the type of loan or the type of property securing the mortgage. Although similarities exist in the underwriting of the different types of residential mortgage loans (conventional, FHA, VA) the differences are more procedural and not of great significance.

Understanding Risk: The underwriting involved to determine the risk requires the gathering and analysis of much information about both the applicant and the real estate that will secure the mortgage loan. On any single residential loan, three separate underwriting reviews could occur at various stages of the mortgage lending cycle by the following parties: Mortgage Lender Mortgage Insurer (Guarantor) Permanent Investor

A Mortgage Lender analyzes the risk and determines whether to lend funds at a certain interest rate to a borrower for a period of time secured by a certain piece of real estate. A Mortgage Insurer determines if mortgage insurance is to be written or a guarantee made based on the loan as submitted. A Permanent Investor determines if the mortgage or mortgages as submitted will be purchased.

Underwriting Guidelines: No single uniform set of underwriting guidelines exists for all residential mortgage loans. To a great extent, the underwriting guidelines of both Fannie Mae and Freddie Mac are the core standards that most lenders attempt to follow. Even those lenders who don’t intend to sell loans to theses two secondary mortgage market players should attempt to follow these well-conceived underwriting guidelines. Underwriting is an art not a science.

Loan-to-Value Ratios: The lower the LTV ratio the safer the loan is for the lender. The reason is that the lower the LTV ratio, the higher the equity investment the borrower will have in the property and thus the more that borrower has to lose. ______Mortgage_Amount___________ =LTV Lesser of Sales Price or Appraised Value

Down Payment (Equity): The money for the down payment (equity) can come from any liquid investment source The existence and history of these funds should be established by a Verification of Deposit (VOD). When was the account opened? How long have the funds been there? In what name(s) is it held?

Income Ratios: The most important test of whether an applicant can afford a particular mortgage loan is by computing the various income ratios.

Borrower Income: Income Sources include these: Regular wages Part-time employment Working spouse Rentals Alimony or child support Commissions Public Assistance The underwriter must judge that the income is likely to continue. The income must be verifiable. Self-employment Bonuses Dividends or interest Retirement annuity Social security

Estimating Housing Expense: Principal and interest on the mortgage being applied for. Mortgage insurance (if any). Property Taxes Hazard Insurance Condominium or cooperative homeowners association dues (if applicable)

Other Obligations: Borrowers will have other obligations, examples include: auto loans, credit card accounts, other mortgage debts, or alimony and child support payments.

Housing Expense Ratio. Housing Expenses. Borrower’s Income Housing Expense Ratio Housing Expenses Borrower’s Income < 28% (CONVENTIONAL LOAN) Total Obligations Ratio Total Obligations Borrower’s Income < 36% (CONVENTIONAL LOAN)

Higher Ratios may be justified by mitigating factors, such as: Demonstrated ability of an applicant to allocate a higher percent of gross income to housing expenses Larger down payment than normal Demonstrated ability of an applicant to accumulate savings and maintain a good credit rating A large net worth Potential for increased earnings because of education or profession

FHA Ratios are: VA Ratios are: 29 percent for the mortgage payment ratio 41 percent for the total debt ratio VA Ratios are: The VA uses a modified residual method in qualifying a veteran for a mortgage loan, and this result is then double-checked against a total debt-to-income ratio of 41 percent.

Loan Classifications Conventional Mortgages Insured conventional mortgages FHA insured mortgages VA guaranteed mortgages “Sharing Default Risk”

Conventional Mortgages: Not insured or guaranteed by federal agency Maximum LTV Ratio of 80% (occasionally higher) Private mortgage insurance (PMI) usually required on purchases with down payments <20% PMI enables lenders to settle for low (perhaps as low as 5%) down payments. Most PMI policies cover top 20-25% of the mortgage.

Advantages of PMI Borrower can buy house that might not pass VA or FHA inspection Allows small down payment Premiums are lower than FHA because it doesn’t cover entire mortgage Processed quicker than FHA PMI can be canceled when LTV < 80% Rates are determined by market PMI allows lender to sell mortgage in secondary market

Credit History Credit Report: Identifying section Info on age, marital status, dependents, employment, etc... - applicant and co-applicant Credit record Public Records data

The Closing Process The purpose of the closing is to make final settlement between the buyer and seller for costs, fees, and prorations associated with the real estate transaction prior to the transfer of title, and to finalize the loan agreement between the buyer/borrower and the lender.

Fees and Expenses Financing costs: Loan application fee Credit report fee Loan origination fee Lender’s attorney’s fees Property appraisal fee Fees for property survey Fees for preparation of loan amortization schedule Loan discount points Prepaid interest

Prorations, Escrow Costs, and Payments to Third Parties Property Tax, Prorations, and Escrow Accounts Mortgage Insurance and Escrow Accounts Hazard Insurance and Escrow Accounts Mortgage Cancellation Insurance and Escrow Accounts Title Insurance, Lawyer’s Title Opinion Release Fees Attorney’s Fee Pest Inspection Certificate Real Estate Commission

Statutory Costs Recording fees. Fees paid for recording of the mortgage and note in the public records. Transfer tax. A tax usually imposed by the county on all real estate transfers.

Requirements under the Real Estate Settlement and Procedures Act (RESPA) The essential aspects of RESPA fall into seven areas that are used here to facilitate discussion: Consumer information Advance disclosure of settlement costs Title insurance placement Prohibition of kickbacks and referral fees Uniform settlement statement Advance inspection of uniform settlement statement Escrow deposit

Settlement Statement I. Amount Due from Buyer: II. Amount Due to Buyer: (A) Purchase Price $76,700.00 Sale Price Plus: Settlement Charges County Tax Proration 2,909.69 615.76 Plus: County tax proration Less: earnest Money Mortgage Loan 1,000.00 61,360.00 Less: Payoff of existing loan Settlement charges* 21,284.15 4,607.00 Net Amount Due from Buyer $17,865.45 Net amount due to seller $51,424.61 Buyer’s Share of Settlement Changes: *Seller’s Hare of Settlement Charges: Loan origination fee $614.00 *Broker commission $4,602.00 Loan Discount 614.00 *Recording fee 5.00 Appraisal fee 125.00 Credit report 45.00 Mortgage insurance Application fee 50.00 Interest (7 days @ $15.55) 108.85 Homeowners insurance 552.00 2 months premium-escrow 92.00 2 months property tax-escrow 132.84 Title insurance (lender) 100.00 Recording fee 31.00 Closing fee 75..00 Title insurance 350.00 Pest inspection 20.00 Total $2,909.60 $4,607.00