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 home buyers' 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 home buyer 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 home buyer
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 home buyers 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 home buyer's gross monthly
income. With loans guaranteed by the Department of Veteran's Affairs
(VA), lenders measure prospective home buyers 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.
- FHA Loans
- 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 home buyers 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 home buyers 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.
Home buyers 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 home buyer'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 home buyer 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 home buyer. 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 home buyers 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.