© 2012 Cengage Learning

Residential Mortgage Lending: Principles and Practices, 6e Chapter 13 Underwriting the Residential Mortgage Loan

© 2012 Cengage Learning Objectives After completing this chapter, you should be able to: – State the purpose of underwriting guidelines – Explain why the initial interview is so important to the underwriting process – Identify the different types of risks analyzed in the underwriting process and the effect on pricing – Calculate the different kinds of ratios commonly used in underwriting: loan-to-value, housing expense, and total debt – List the types of information analyzed by the underwriter in each of these areas: applicant’s financial capability; applicant’s credit history; and the collateral (real estate) securing the mortgage – Compare Automated Underwriting Systems to Manual Comprehensive Risk Assessment Guidelines – Understand the issues behind discrimination in mortgage lending and what the Federal Government has done about this activity

© 2012 Cengage Learning Residential Loan Risks Credit—based on the credit history of the applicant Collateral—the condition and value of the property being secured Default—the repayment of the debt Fraud—approval and pricing based on intentional deception Compliance—failure to follow all state and federal regulations involved Interest rate—changes in market interest rates vs. loan interest rate Price and market—changes in the value of the loan before it is sold Liquidity—either lack of funding for a loan or prepayment of an existing loan Secondary market—several risks, including losing an investor or program Portfolio—changes in market value due to internal or external conditions Servicing—changes in market value or failure to meet servicing requirements

© 2012 Cengage Learning Three C’s of Lending Capacity – do the applicants have the financial resources to repay the proposed and existing debts? Credit – do the applicants have an acceptable credit history? Have they used credit responsibly? Collateral – is the property sufficient collateral to secure the loan?

© 2012 Cengage Learning LTV = Mortgage Amount ÷ Lesser of Sales Price or Appraised Value ● 90% LTV loan is twice as likely to default as an 80% LTV loan. ● 95% LTV loan is nearly three times the default risk as an 80% LTV loan. ● 97%LTV loan is nearly six times the default risk as an 80% LTV loan.

© 2012 Cengage Learning Credit Scores

© 2012 Cengage Learning Underwriters Review of Appraisal 1. Location/Site. This is always the most critical of all evaluating factors. a. Property must be residential in nature, not agricultural or commercial. b. Adequate sewage and water facilities and other utilities are present. c. Property is readily accessible by an all-weather road. d. No danger is posed to health and safety from immediate surroundings (including environmental hazards). 2. Physical security. The age, equipment, architectural design, quality of construction, floor plan, and site features are considered when establishing the adequacy and future value of the physical security. a. Evidence of compliance with local codes should be in the file for underwriter’s review. b. Topography, shape, size, and drainage of a lot are equally important. c. View, amenities, easements, and other encroachments may have either a positive or negative influence on market value.

© 2012 Cengage Learning Underwriters Review of Appraisal 3. Local government. a. The amount of property tax can have a great effect on future marketability. b. Building codes, deed restrictions, and zoning ordinances help to maintain housing standards and promote a high degree of homogeneity. 4. Comparable sales. This is a critical section for residential real estate loans. a. The comparables are truly similar to the subject in regards to location, type of real estate, and time of sale. b. The adjustments exceed 10 percent for any line item. c. The total of all adjustments, disregarding plus and minus signs, exceeds 25 percent. d. Adjusted sales prices “bracket” the market value of the subject property.

© 2012 Cengage Learning AUTOMATED UNDERWRITING SYSTEMS Determines the creditworthiness of an applicant by having a computer software program assign values to certain attributes and facts for each application.

© 2012 Cengage Learning UNDERWRITING GUIDELINES The lender’s underwriting standards should be clearly written, nondiscriminatory, and available for review by the general public.

© 2012 Cengage Learning UNDERWRITING Decision When the lender has a fully processed mortgage loan application, the lender makes a credit decision that either accepts, rejects, or modifies the mortgage loan application.

© 2012 Cengage Learning What Do You Think? Identify the types of risks present in residential mortgage lending. Which of these does an underwriter evaluate? How do underwriting guidelines mitigate the risks in mortgage lending? What are the pros and cons of Automated Underwriting Systems?

© 2012 Cengage Learning What Do You Think? How does the Loan-To-Value (LTV) and Combined LTV (CLTV) affect the way the underwriter reviews a mortgage application? Why are these ratios so important? What compensating factors might offset a total debt ratio that exceeds a lender’s guideline?

© 2012 Cengage Learning What Do You Think? What are credit scores? How does the secondary market use credit scores and how are they different from mortgage scores? In what ways does a “Comprehensive Risk Assessment” differ from other underwriting reviews?

© 2012 Cengage Learning Check Your Understanding 1.Underwriting is the process of analyzing risk. 2.In underwriting residential mortgage loans, the lender should follow a strict formula. 3.Uniform underwriting guidelines exist for all residential mortgage loans. 4.When it is obvious that a potential borrower is not qualified, the lender should decline to take the application. 5.Once an application is submitted to the lender, the lender is subject to disclosure requirements.

© 2012 Cengage Learning Check Your Understanding 6.It would be improper for the lender to counsel an applicant during the initial interview. 7.Lenders should have a written underwriting and loan policy to review with potential borrowers. 8.Long-term debt is defined as monthly obligations extending more than three years into the future. 9.Acceptable ratios for housing expenses and long term debt for conventional and FHA loans are both based on gross monthly income. 10.One way of verifying a self-employed applicant’s income is to review federal income tax returns from previous years.

© 2012 Cengage Learning Check Your Understanding 11.HUD-FHA regulations define housing expenses as principal and interest payments. 12.The appraisal establishes the adequacy of the security as well as the loan-to-value ratio. 13.The appraiser in estimating property value considers building codes and zoning ordinances. 14.To reject an application because of the property’s location and neighborhood is discriminatory. 15.Income from a part-time job may not be considered when evaluating the financial capability of the borrower.

© 2012 Cengage Learning Check Your Understanding 16.Use of investigative reports relating to the applicant’s character and reputation is permissible. 17.Under the Equal Credit Opportunity Act (ECOA), a lender must certify to consumer reporting agencies the purpose for which the credit information is to be used. 18.ECOA permits asking if applicants are married or unmarried. 19.Lenders have 30 days from the date of application in which to notify the applicant whether the loan request has been approved or rejected. 20.Attitude toward credit needs to be considered only when the applicant’s income does not qualify.