1. Qualifying the Borrower
Chapter 13
Qualifying the Borrower

2. Qualifying the Borrower
Before agreeing to make a real estate loan, a lender will evaluate both the borrower’s ability and willingness to repay the loan, and whether or not the property is of sufficient value to serve as collateral for the loan.
This evaluation process is called LOAN UNDERWRITING.
The individual who conducts this process is called an UNDERWRITER.
The primary concern of the underwriter is to minimize the amount of the lender’s risk.

3. I. FHLMC/FNMA Underwriting Standards

4. Freddie Mac/Fannie Mae Underwriting Standards
According to the Freddie Mac:
“underwriting mortgage loans is an art, not a science. It cannot be reduced to mathematical formulas, but requires sensitive weighing of the many aspects of the loan.”
There are many factors related to the borrower’s loan application that an underwriter will consider; they will all relate to income, net worth, and credit history.

5. A. INCOME STABLE MONTHLY INCOME DEBT SERVICE RATIO
Conventional lenders consider a borrower’s income adequate for a loan if the proposed payment of principal, interest, taxes, and insurance does not exceed 28% of his or her stable monthly income.
STABLE MONTHLY INCOME
DEBT SERVICE RATIO

6. 1. Stable Monthly Income
As mentioned earlier, stable monthly income is the base income of the borrower, plus earnings from acceptable secondary sources.
Before concluding there is a sufficient quantity of income, the underwriter must decide what portion of the total verified earnings are acceptable as a part of his or her stable monthly income.
They will review the following:
Quality
Durability
Bonuses, Commissions, and Part-Time Earnings
Overtime
Unemployment and Welfare
Alimony, Child Support, or Maintenance
Income from Other Family Members
Self-Employment Income
Co-mortgagor
Rental Income
Verifying Income

7. 2. Computing Monthly Earnings
When converting hourly wages to monthly earnings, multiply the hourly wage by 40 (hours in a work week), then multiply by 52 (weeks in a year) and divide by 12 (months in a year).
Example:
Hourly Wage: $20.00
Weekly Income: $20.00 x 40 = $800
Annual Income: $800 x 52 = $41,600
Monthly Income: $41,600 ÷ 12 = $3,466.67

8. 3. Employment History
When evaluating the elements of a borrower’s income (quantity, quality, and durability), the underwriter will analyze the individual’s employment stability using the Request for Verification of Employment.
A borrower with a history of steady, full employment will be given more favorable consideration than one who has changed employers frequently, unless the changes are properly explained.
As a general rule, a borrower should have continuous employment for at least two years in the same field.

9. 4. Advancement
If the borrower has changed employers for the sake of advancement within the same line of work, the underwriter will likely view the change favorably.
On the other hand, persistent job hopping without advancement usually signifies a problem of some kind and an underwriter will tend to regard the individual’s earnings as unstable.

10. 5. Education and Training
Special education or training that prepares an individual for a specific kind of work can strengthen a loan application.
Such education or training can offset minor weaknesses with respect to earnings or job tenure if the underwriter is convinced there is a continuing demand for individuals in this line of work.

11. B. NET WORTH
According to Fannie Mae, “accumulation of net worth is a strong indication of credit worthiness.”
A borrower who has built up a significant net worth from earnings, savings, and other investment activities clearly has the ability to manage financial affairs and accumulate wealth.
An individual’s NET WORTH is determined by subtracting personal liabilities from total assets.

12. 1. Required Reserves After Closing
As a safeguard against unexpected bills or temporary loss of income, and as a general indicator of financial ability, Fannie Mae requires the borrower to have sufficient cash on deposit, or in the form of highly liquid assets, to cover two months’ payments (principal, interest, taxes, insurance, and if applicable, mortgage insurance) after making the down payment and paying all closing costs.
FHLMC guidelines require a minimum of two months’ payments for all owner-occupant loans, without regard to loan-to-value ratio, and three to six months for non-owner-occupant loans.

13. 2. Verification of Assets
Included in every loan application is a section devoted to assets.
The underwriter will take whatever steps are necessary to verify the nature and value of assets held by the borrower.
LIQUID ASSETS

14. 3. Verification of Deposit
The underwriter will use the Request for Verification of Deposit form to prove the borrower has the necessary funds in his or her bank account(s).
This form is sent directly to the bank and returned to the underwriter without passing through the borrower’s hands.

15. 4. Alternative Verification Method
When Fannie Mae changed its rules regarding verification of income (early 1987), it also changed its rules on verification of deposits.
Lenders may now use an alternative method of verifying deposits: the borrower may submit the original bank statements for the previous three months to verify sufficient cash for closing.

16. 5. Financial Statement
If a borrower’s assets are substantial and diverse, an audited financial statement may be the best way to explain the borrower’s creditworthiness to the underwriter.
A FINANCIAL STATEMENT is a summary of facts showing the individual’s financial condition; it contains an itemized list of assets and liabilities which serves to disclose net worth.

17. 6. Real Estate for Sale
If a borrower is selling a property to raise cash to buy the subject property, the equity may be counted as a legitimate asset.
EQUITY is the difference between the market value of the property and the sum of the selling expenses, mortgages and other liens against the property.
Equity is what the buyer should receive from the sale of the property.

18. 7. Other Assets
Any assets held by the borrower will help the loan application.
Assets, other than cash and real estate, typically listed in a loan application include automobiles, furniture, jewelry, stocks and bonds, and cash value in a life insurance policy.

19. 8. Gift Letter
If an applicant lacks the necessary funds to close a transaction, a gift of the required amount from relatives is usually acceptable to the underwriter.
The gift should be confirmed by means of a (gift) letter signed by the donor.
The letter should clearly state that the money represents a gift and does not have to be repaid.

20. C. CREDIT HISTORY
As a part of the loan evaluation, the underwriter will analyze the credit history of the borrower; this is accomplished by obtaining a credit report from a responsible credit rating bureau.
A high FICO credit score is the standard by which a borrower’s creditworthiness is determined.
Here are some helpful hints to increase your credit score:
1. Pay bills on time.
2. Limit outstanding debt.
3. Have a long credit history.
4. Restrict your credit.
5. Too much credit.

21. Figure 13-7

22. 1. Explaining Derogatory Credit
Most people try to meet their credit obligations on time; when they do not, there is usually a reason.
A loss of job, hospitalization, illness, death in the family or even divorce can create extraordinary financial pressures and adversely affect a credit report.
It may be possible to successfully explain the ratings if the borrower can show that the problems occurred during a specific period of time for an understandable reason, and that prior and subsequent credit ratings have been good.

23. 2. Bill Consolidation, Refinancing
Even in the absence of derogatory ratings, there are matters that can be revealed by a credit report which might indicate the borrower is a marginal credit risk.
If an individual’s credit pattern is one of continually increasing liabilities and periodically “bailing out” through refinancing and debt consolidation, he or she may be classified as a marginal risk.
The pattern suggests a tendency to live beyond a prudent level.

24. 3. Illegal Discrimination
A borrower must be of legal age before he or she can qualify for a loan; after that, an applicant’s age is not a valid reason for rejecting a loan.
In addition to age, a lender cannot use as a basis for denying a loan the race, color, creed, national origin, religion, handicap, familial status, marital status, or sex of the borrower.

25. Figure 13-8

26. II. Summary of Qualifying the Borrower

27. Summary
A buyer’s ability to qualify for a real estate loan depends on many factors, all of which relate to income, net worth, and credit history.
While there are established guidelines for determining adequacy of income in relation to proposed housing expense, it would be wrong to apply them too rigidly.
Considering the quality, quantity, and durability of a buyer’s income and relating it to net worth is substantial enough to indicate an ability to manage financial affairs.
A borrower must be both able and willing to pay the housing expense.

28. III. FHA Underwriting Standards

29. FHA Underwriting Standards
FHA’s qualifying ratios are based on the borrower’s gross income.
The FHA will allow a maximum ratio of housing expense-to-gross income of 31%
FIXED PAYMENTS
The maximum ration for housing expenses plus fixed payments-to-gross income is 43%

30. Sample Housing Expense:
$ principal and interest
40.00 property taxes
15.00 homeowner’s insurance
33.00 maintenance expense
80.00 utilities expense
-0- homeowners’ association dues
-0- assessments
$ total housing expense
The FHA will allow a maximum ratio of housing expense-to-gross income of 31%.
$ (housing expense) ÷ .31 = $2, minimum gross income necessary

31. Fixed Payments Example:
In addition to its concern for the borrower’s ratio of housing expense-to- income, FHA will want to know the borrower can support the family’s fixed monthly payments as well.
The maximum ratio for housing expense plus fixed payments-to-gross income is 43%.
Example:
$ housing expense
fixed monthly payments:
92.65 auto payment
20.00 revolving account
$ Total
$ (housing expense and fixed payments) ÷ .43 = $1, minimum gross income necessary.

32. IV. VA Qualifying Standards

33. A. MINIMUM RESIDUAL STANDARDS ARE GUIDELINES
The balance available for family support is an important factor in evaluating a VA loan application, but is not the only consideration.
The VA standards are intended to be guidelines in judging the borrower’s relative strength or weakness with regards to residual income, which is only one of the many factors to be considered in underwriting VA loan applications.

34. B. OTHER FACTORS
In addition to the residual income standards, other important factors considered in underwriting a loan application include:
1. The borrower’s demonstrated ability to accumulate cash or other liquid assets.
2. The borrowers demonstrated ability to use credit wisely and to avoid incurring an excessive amount of debt.
3. The relationship between the shelter expense for the property being acquired and the expense that the borrower is accustomed to paying.
4. The number and ages of the borrower’s dependents.
5. The locality and general economic level of the neighborhood where the property is located.
6. The likelihood that the borrower’s income may increase or decrease.
7. The borrower’s employment history and work experience.
8. The borrower’s demonstrated ability and willingness to make payments on time.
9. The amount of any down payment made.
10. The borrower’s available cash after paying closing costs and other prepaid items.

35. C. INCOME RATIO ANALYSIS
In addition to residual income, a ratio based on total monthly debt payments to gross monthly income will be considered by a VA underwriter.
The ratio is determined by taking the sum of the housing expense and monthly obligations and dividing that by gross income.
If the obligations-to-income ratio is 41% or less, the underwriter may approve the loan.

36. V. CHAPTER SUMMARY
The loan underwriting process evaluates both the property and the borrower’s willingness and ability to pay off the loan.
An underwriter will make a determination of these factors by analyzing the borrower’s current income, debt levels, overall net worth, and credit history.
For conventional loans, these will be the guidelines of Fannie Mae and FHLMC. FHA and VA programs have slightly different guidelines.
Conventional and FHA loans emphasize income-to-debt ratios.
VA standards emphasize residual income requirements as well as income-to-total debt ratios.
As a result, the VA program is somewhat more lenient.