UNDERSTANDING LOANS

Understanding the loan process

Much of a homebuyers' uneasiness is due to the fact that they don't know what the process is and what to expect. Buying a home can be one of the most stressful experiences of our lives, adding to this anxiety is waiting for the mortgage to be approved. You know checks and verifications of information are taking place-but what makes the difference between getting or not getting that loan, and how long does it take? We've put together information to help you understand the loan process and eliminate at least some of your anxiety.

Are You Worth the Risk?

The lender assumes a long-term risk when lending a prospective homebuyer money, the assumption is that the borrower will eventually repay the loan and in the short term can make the loan payments on time. Just as wise stock market investors carefully research the companies where they plan to buy stock, careful mortgage lenders investigate the financial background of each loan applicant. Once lenders analyze the risk of lending (making the investment) by reviewing all the information collected and establishing eligibility...the lender then decides whether to extend you, the homebuyer, credit. The lender then selects 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, investors or institutional investors. It's up to the lender to establish that an applicant is qualified, but to approve a loan that will become delinquent doesn't help anyone.

Is Your Income Sufficient?

Following the loan application, the lender verifies your employment and financial information.

Income Requirements
A general rule is; you can qualify for a loan of up to twice the family's income (i.e. a family making $30,000 a year can usually qualify for a mortgage up to $60,000). Often the amount you earn may not be as important as how you earn it. If bonuses and commissions make up a large percentage of your income (they can vary greatly from year to year), lenders can be reluctant to depend on them. The lender will probably want to verify your bonus and commission status for the past two or three years to get a better idea of your average earnings. Lenders will also want verification if large portions of your salary are based on overtime pay. The mortgage lender will ultimately make a decision as to how much to allow for these additional sources of income. If you are self-employed, you should plan on providing balance sheets, 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 income from securities.

Income/Expense Standards
Lenders use a set of general standards, or lender guidelines (income/expense ratios) to test the application for qualification. These standards are based on the lending industry's experience with what an average homeowner can spend on mortgage payments and also take care of other long-term financial obligations. Of course lenders do use their own discretion in making the final decision.

Debt
Lenders usually define long-term debt as monthly expenses extending more than 10 months into the future and these expenses should not exceed 33% - 36% 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% of the homeowner's gross monthly income.

How's Your Credit?
Lenders will want to examine the risk of not getting the money back, before extending you credit, so they will look at four crucial aspects of your credit history when you apply for a mortgage:

  1. History of past credit - What were the size and terms of past loans?
  2. Type of credit - Was it real estate, auto, personal or other installment loans?
  3. Attitude toward credit - Are active accounts current, and is there any recent bankruptcy or judgment?
  4. Lapses in employment or debt repayment - How many unexplained lapses are there, and for how long?

If you have been through bankruptcy or foreclosure proceedings within the past seven years, be prepared to give full details and provide copies of documents. You will also be asked to provide details if you pay alimony, child support or separate maintenance. These obligations are treated like debt payments by most lenders and will be part of the underwriting analysis. Armed with this information, lenders can develop a fair idea of how you will handle your responsibilities once you have signed the loan contract.

Can Afford The Down Payment?

Lenders expect homebuyers to make the down payment of between 10 - 20% of the asking price for the house. FHA and VA loans require a smaller down payment (0 - 5%) and to pay their share of the closing costs (3 - 6% of the loan amount). A lender can make you a loan for as little as 5 percent down, however, you'll pay a premium for the first year and an additional monthly fee in subsequent years and be required to carry private mortgage insurance.

Homebuyers may use funds from: savings, stocks/bonds, Individual Retirement Accounts (IRAs), pension funds, real state holdings, life insurance policies, mutual funds or employee savings plans for the down payment and the closing costs. Homebuyers may also use a gift, or money given by a parent or other relative that requires no repayment (you will need to provide your lender a letter signed by both the giver(s) and the receiver(s) stating the gift). A gift may be up to $10,000 per year without either party being taxed. A married couple, could give a child or spouse as much as $40,000 tax-free for a down payment.
If you are making a down payment of less than 5 percent using gift money, the gift donor must be a relative and provide a letter stating their relationship to you, the amount of the gift and the fact that no repayment is expected.

Is The House You Want to Buy Worth The Price?

Mortgage lenders also examine the real estate being purchased to make sure the property is salable, in case of foreclosure. The property's acceptability is established by an independent appraisal.

The appraiser looks at what the home is worth today, as well as how the neighborhood's dynamics will affect the property value in the future.

The three main points the appraiser checks are:

  1. Physical security of the property - Age, structural soundness, landscaping, etc.
  2. Location - The kind of neighborhood, surrounding houses, access to transportation, commercial development nearby, etc.
  3. Local government's plans for the area - How zoning and taxes will affect the property in the years to come.

The appraiser does not create value, they interpret the market to arrive at a value estimate. Considerable research and collection of data must be accomplished before the appraiser can arrive at a final opinion of value. There are many types of value, such as Fair Market Value, Insurance Value, Tax Value and Value In Use, you'll need to define precisely the purpose of your appraisal.

The Loan Application

Most lenders today are not requiring a face-to-face meeting and accept a completed application by mail or online. Many lenders today will qualify you for a loan before you begin to shop for a home. Knowing how much money you are qualified to borrow can save you time and prevent disappointment in your housing search. You should be aware of the general interest rates and fees being charged in the area.

Lenders will quote a rate and fee at the time the application is taken and then can offer to guarantee, or "lock" the rate quote for a specified length of time. A rate lock protects you from rising interest rates during loan processing, but also requires you to close the loan at the rate even if rates decline prior to closing. Lock periods can run from 10 to 60 days, longer periods are available in some cases for an additional fee. Remember, the lock period should be long enough to get you through the estimated closing date, if your closing is at least 60 days away then a 30-day lock won't protect you.

Lenders have two extremely important limitations on credit information gathering: (see the Credit Information Safeguards box on the right.) Lender's are prohibited by law from asking questions concerning the applicant's spouse - (unless the spouse will be contractually liable, their 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).

Review your finances and be prepared

Examine Your Finances

Shopping for a mortgage can be stressful and intimidating, even more so if you're not prepared, so read this section and get ready for the loan process. Preparing a budget is a good way to start, it will help you know whether you have enough money for a down payment, closing costs, monthly mortgage payment, taxes, insurance, and other costs associated with homebuying. Determine how your mortgage payment will fit your current budget and give plenty of thought to your future obligations (as best as possible) 15 to 30 years down the road.

Review your income and expenses, both current and projected to determine what you can comfortably manage each month. Don't forget to include related insurance, taxes, homeowner association dues and any other costs that will be rolled into the mortgage payment.

Lenders use guidelines to determine whether prospective homebuyers will be able to make their monthly mortgage payments comfortably. Don't make the mistake of going for a mortgage that you can't afford, you'll face the possibility of losing the roof over your head, as well as damaging your ability to purchase a home later.

Review Your Credit Record

Having a good credit record means that you pay your rent and other bills on time. However, having less than perfect credit doesn't mean you can't get a mortgage loan. Understanding credit before you meet with your lender/broker can make the total loan process easier. Your lender will request a credit report as part of the mortgage loan process, so it's advisable to review your report before you meet with your lender. If there are discrepancies or errors in your credit report, you should contact the credit bureau to correct them.

  1. Credit bureaus gather information from credit card companies, banks, department stores, and other firms to compile a credit record of your debts and how you have repaid them.
  2. Your credit history shows how well you have paid your debts in the past.
  3. Capacity is your financial means for repaying your debt.
  4. Capital indicates whether you have enough money for a down payment and closing costs.
  5. Collateral serves to protect the lender if you fail to repay the loan.

What about Pre-Qualifying?

Pre-qualify for a Loan

Pre-qualification is a good first step in the home-buying process, it occurs before the loan process actually begins. You provide information to the lender about your income and debts, who in turn makes a financial determination about how much house you may be able to afford. Different loan programs may lead to different values, depending on whether you are qualified for them, so be sure to get a pre-qualification for each type of program you are suited for.

Advantages of pre-qualifying

  1. Being pre-qualified can demonstrate to a seller that you're a serious buyer, not just shopping.
  2. Knowing how much you can afford will help you focus on your house hunting.
  3. Completing the final mortgage application will go faster since you've already provided much of your information.

What you typically need to pre-qualify

You can save time in the pre-qualification process by preparing some information before you get started:

  1. Type of home and approximate price
  2. Type of loan you want
  3. The amount of down payment you plan to make
  4. Personal information (name, phone number, address, date of birth)
  5. Employment history
  6. Social Security number
  7. Financial information (monthly income, current debts, assets)

What about Pre-Approval?

Pre-approval is much more in-depth and highly recommended early in the home buying process. Typically your pre-approval is submitted along with any bid you make on a property, if another buyer bids on the same property with a pre-qualification, your pre-approval will demonstrate to the seller that you are a much more qualified buyer. Always ask a lender if they offer a program that will allow you to send and clear (verify income and assets) your pre-approved loan conditions and offers you a protection option for your rate during the home search process.

What you typically need for pre-approval

You can save time in the pre-approval process by preparing some information before you get started:

  1. Type of home and approximate price
  2. Type of loan you want
  3. The amount of down payment you plan to make
  4. Personal information (name, phone number, address, date of birth)
  5. Employment history - Names, addresses and telephone numbers of all your employers for the last two years.
  6. W-2s for the two most recent years. You may also provide other income information, such as social security, pension, interest or dividends, rental income, and child support or alimony, if you choose to have them considered. Self-employment income may also be considered.
  7. Pay stubs. Provide your pay stubs that cover the 30-day period before the date of your mortgage application.
  8. Federal income tax returns. If you are self-employed, or more than 25% of your income comes from commission, overtime or bonuses, you may need to provide complete copies of federal income tax returns you filed for the two most recent years.
  9. Social Security number
  10. Current debts. You'll need to provide the account numbers, current balances and the minimum monthly payments of all credit accounts, such as loans, credit cards, child support and other payments you make each month.
  11. Financial assets
  12. Bank statements. You may need to provide statements from all your accounts (checking, savings, mutual funds, money markets, certificates of deposits, 401(k) or other retirement accounts) for the last two months to verify the exact amount of cash you have available for your down payment and other costs associated with your home purchase.

Steps in the Loan Process

Pre-Qualification

A pre-qualification DOES NOT automatically give you approval status, in this process the lender gathers information about your income and debts and makes a financial determination about how much money you may be able to afford. Pre-qualification is a comparison of income to debt, this step will only tell you the price range of the home loan you qualify for according to industry qualification standard ratios. Be sure to get a pre-qualification for each type of loan you are suited for - different loans can lead to different values.

Pre-Approval

Pre-approval is a more in-depth process than pre-qualification and is highly recommended that you obtain it early in the home buying process. Pre-approvals are conditioned loans from a mortgage provider and are typically submitted along with any bid you make on a property.

Loan Application

The application is actually the beginning of the loan process, The borrower (you) complete a mortgage application with the loan officer (or through mail or online) and supply all the required documentation for processing.
The various fees and down payment are discussed at this time and you will receive within three days;

  1. Good Faith Estimate (GFE) a report from your lender that outlines the costs you will incur to get your mortgage. It is based on the lender's typical loan origination costs for the area where your home is located. The estimate usually changes between application and closing. that itemizes the rates and costs for obtaining the loan.
  2. Truth-In-Lending statement (TIL) the terms and conditions of a mortgage, including the APR and other charges. This document outlines the costs of your loan, and it is given to you so you can compare the costs with those of other lenders. The following information will most likely be required for the loan application:

Personal Information

  1. Current address and telephone number.
    Name and address of your landlord(s) or mortgage lender(s) for the past two years.
  2. Social security numbers of you and your spouse (or other co-borrowers),
  3. Age,
  4. Marital status,
  5. How many dependents and their ages,
  6. Years of schooling,
  7. Your current housing expenses, including rent or mortgage payments, real estate taxes and insurance (your mortgage payment may include tax and insurance funds).

Employment History and Sources of Income

  2. Recent paycheck stubs and Federal W-2 forms for two years (some lenders require full Federal tax returns).
  3. At least two years employment history with employer's name and address, your job title or position, length of time on the job, salary, bonuses, commissions and average overtime pay.
  4. You will sign a Verification of Employment (VOE) form.
  5. If self-employed, full tax returns and financial statements for 2 years, plus a profit and loss statement for the current year to date.
  6. A written explanation if there are gaps in your employment record, because of circumstances such as illness or - layoffs, or for any other reason.
  7. If you are relying on income from other sources, such as rental property, social security or disability payments, child support, etc., you must provide adequate proof of the source. Appropriate documents could include canceled checks, copies of leases, certification of benefits, divorce decrees and similar evidence.

Personal Assets

  1. All bank accounts, checking, savings, and money market accounts, with the name and address of the institution, name(s) on the accounts, account numbers and current account balances.
  2. Recent bank statements for at least two months.
  3. Current market value of stocks, bonds, CDs and other investments. Vested interest in all retirement funds.
  4. Face amount and cash value of life insurance policies in force.
  5. Make, model, year and value of automobiles owned.
  6. Address and market value of all real estate owned along with the amount of rents collected, the mortgage on the property and the monthly mortgage payments (a profit and loss statement will be required for investment properties).
  7. Value of other personal property such as furniture.
    You will sign Verifications of Deposit (VOD) for each of the institutions (or a general authorization) where you have savings or checking accounts. Differences between the account balances reported by the institution and the balance you give for the loan application have to be reconciled. The lender will look for the source of funds which you will be using for the down payment and closing costs and fees.

Personal Indebtedness

  1. How much and who you owe...debts include automobile loans, credit cards and retail store accounts, finance company, bank, credit union loans and existing mortgages, and/or home equity loans.
  2. You will need to provide current balances and monthly payments on all of your current bills, loans and other debts.
  3. You will need to give the account or loan number, the monthly payment, the number of payments remaining and the outstanding balance.
  4. This information will then be verified by a credit report ordered by the lender. If you have had credit problems, you should inform the lender. Lenders recognize that unemployment, illness, marital problems or other financial difficulties can temporarily impair your credit rating. Prepare a written explanation of the circumstances to be included with the loan application, the lender must consider this written explanation as part of the underwriting analysis. If the problem has been corrected and your payments have been made on time for a year or more, then your credit will probably be judged as satisfactory. If you have been through bankruptcy or foreclosure proceedings within the past seven years, be prepared to give full details and copies of any applicable documents.
  5. You will also be asked to explain the details if you are required to pay alimony, child support or separate maintenance, these obligations are treated like debt payments and will be part of the underwriting analysis.

Additional Information

  1. You will be asked to sign a section of the loan application which contains your certification that the information you have provided is correct to the best of your knowledge; your promise to advise the lender of any changes in the information on; and your consent to (1) verification of the application data, (2) submission of account history to credit reporting agencies, and (3) transfer of the loan or loan servicing to successors to the original lender.

The last part of the application requests information on the race and gender of the applicants, the lender is required by federal law to request the information, providing this information is completely voluntary on your part and has no bearing on your loan application. The Federal Government uses this data to monitor lenders' compliance with fair housing and equal credit opportunity laws. Loan officers make every effort to collect all data at the time of the loan application, but cannot foresee every circumstance. If there are particular circumstances surrounding a loan application, the lender may require additional information or documentation after the application has been submitted for approval. Requests for additional information do not necessarily mean you'll be turned down, be sure to respond promptly with any information request. At the time the application is taken, you will probably be asked to pay for the credit report and appraisal fees. Based on the information collected in the application, the loan officer may be able to pre-qualify you for the loan requested, but cannot approve the loan. Approval is done by the lender's underwriters after all documents and information have been received and verified. The lender must provide you within three business days after completing the application, a Good Faith Estimate.
Click here to download our handy Checklist for a Loan Application.

Loan Processing

After you have a contract on a home you should contact the lender/loan officer you have chosen and provide the following information:

1. The full property address.
2. Closing date as per contract.
3. If you are purchasing a Townhouse or Condo, have the name of the homeowner or condo association as well as the address, contact person, and contact number at the association.

You should ask your loan officer what the conditions of the loan are, make a note of the conditions you are responsible for, such as:

1. Asset verification.
2. Income verification.
3. Credit conditions.
4. Any other personal conditions that you are able to provide right away.

After you receive your loan package, review the loan documentation thoroughly, sign where it is indicated and return the package to the lender as soon as possible. You should receive a copy of all documentation in the loan package for your file.

Processing usually takes between 5 and 20 days of the application. The processor's job is to put together a package that can be underwritten by the lender. The processor reviews the credit reports, verifies the borrower's debts and payment histories, as well as reviewing the appraisal and survey. This step checks for borrower or property issues that may require further review.

Underwriting

Underwriting is the process of reviewing and evaluating the information provided on your application, then making a decision as to whether you, the borrower, qualifies for a loan. The underwriter's job is to answer basic questions such as:

  1. What is the source of your income, and is it stable?
  2. Is your income adequate to cover the expense of the new mortgage payment?
  3. How much long-term debt (debt that will take longer than 10 months to pay) do you have?
  4. How's your credit history - helps lenders evaluate your ability to manage debt. It reflects how you've handled repayment of bills in the past.
  5. What is the property appraised at - provides an estimated market value of the home that you want to buy, based on similar homes sold in the neighborhood. Lenders loan up to a certain percentage of the property's value, this percentage is called the loan-to-value (LTV) ratio. The rest of the property value is covered by your down payment.
  6. Do you have hazard insurance - or homeowner's policy, which protects you and the lender from loss if the home is damaged or destroyed by fire, storm or other hazards. You're responsible for obtaining hazard insurance prior to closing and for providing proof of insurance to your lender. The lender may also require additional insurance against loss by flood or earthquake.

The underwriter is responsible for determining whether the combined package assembled by the processor is an acceptable loan. If more information is needed, the loan is put into "suspense" while the borrower is contacted to supply more documentation.

After approval

After the lender has approved the loan, you will receive a commitment letter which spells out the terms of the loan and how long those terms will be offered. Read it carefully, you may still have conditions to satisfy. Usually you accept the commitment by returning a signed copy to the lender within five to ten days and you may have to pay part or all of the origination fees at this time. If the loan does not close within the specified commitment period, the terms are subject to change.

In cases where a closing is scheduled soon after approval, the lender provides verbal approval instead of a commitment letter. Make sure you understand the terms of the approval, ensure that the processor has scheduled the closing with the title company and that your loan has been fully processed and reviewed.

You are assured of the financing, once the commitment letter or approval has been received.

Mortgage Insurance

Mortgage insurance underwriting occurs when you have a less than 20% down payment. The loan is submitted to a private mortgage guaranty insurer, who provides extra insurance to the lender in case of default.

Pre-Closing

During this time the title insurance is ordered, all approval contingencies, if any, are met, and a closing time is scheduled for the loan. The purpose of the closing is to make sure the property is ready to be transferred to you from the seller. To ensure that the transfer can be made, the lender normally prepares the following items ahead of time:

Title search and report - Research of land records, court records and other legal documents to determine if the seller has a clear, marketable title to transfer to you.
Title insurance binder - Provides the result of the title search and assures the lender the title to the property qualifies for a title insurance policy.
Survey - (not required in all states) Confirms the property boundaries are as described in the purchase and sale agreement.
Termite, well, sewer or septic certificate - Certifies the property is free of termites and/or other wood destroying insects, and that the sewage and water supply work properly. The sales contract will stipulate who (you or the seller) is responsible for these inspections and certificates.
Title insurance - Title insurance protects the lender against losses that may be incurred because of a defect in the title, a forgery, a recording error, claims of undisclosed or unknown spouses or heirs, and other risks that did not appear in the public records when the title search was done.
Hazard insurance - Also referred to as a "homeowner's policy", protects you and the lender from loss in the event of damage or destruction to the home by fire, storm or other hazards. You are responsible for obtaining hazard insurance and providing proof of insurance to your lender prior to closing.

Document preparation
Several other documents must be prepared by the lender before the closing:

HUD 1 settlement statement - based on the contract terms it is an itemized list of the credits and charges, for you and the seller.
Loan documents - that grant your lender a lien against the property in order to secure the repayment of your loan. These documents include a promissory note, your legal promise to repay the loan, and a deed of trust/mortgage which is recorded in the public records.
The deed - contains a legal and accurate description of the property and transfers ownership of the property to you.

Make sure you ask to review all your settlement documents and consider asking your attorney to review them, at least one day before you sign them.

Closing

This is the final step, it's when the home is transferred to you. Depending on the laws of your state, the closing may be conducted by:

1. Your lender
2. A title or escrow company
3. Your real estate broker
4. An attorney who represents either you or the seller

At the closing, you will sign many documents, including:

1. Settlement statement
2. Note
3. Deed of trust/mortgage

You will probably be required to pay any remaining down payment and closing costs. The lender "funds" the loan with a cashier's check, draft or wire to the selling party in exchange for the title to the property. This is when you (the borrower) finish the loan process and buy the house. As soon as all the necessary documents and releases are recorded, you will receive the keys to your new home!

Your Rights As a Consumer

Every consumer has the right to equal access under the law, to credit and the right to full disclosure of all costs associated with obtaining a mortgage.
The Equal Credit Opportunity Act (ECOA) provides for equal access to credit regardless of:

- Race
- Religion
- Age
- Color
- National origin
- Sex
- Marital status
- Income from public assistance programs

There are additional protections if you have a physical or mental disability. Additionally, the ECOA requires that you be notified within 30 days of the completed application that your application has been approved as requested, modified, or rejected. Specific reasons for rejection must be given to you, in writing, at the time of rejection or upon your written request. An application is considered complete once the lender has received all the information necessary to make a loan decision. This may include the following information:

- Credit reports
- Employment/income verifications
- Appraisals
- Approvals by insurance companies
- Additional information, as required

Additional consumer protection laws include:

Real Estate Settlement Procedures Act (RESPA)
RESPA requires lenders to give you advance notice of estimated closing costs in purchase and refinance transactions.
Truth-in-Lending Act
The Truth-in-Lending Act requires all lenders to fully disclose, in writing, the terms and conditions of a loan including the Annual Percentage Rate (APR), which reflects the cost of obtaining credit.