Financing Residential Real Estate. Qualifying the Buyer

Transcription

1 Financing Residential Real Estate Lesson 8: Qualifying the Buyer

2 Introduction In this lesson we will cover: the underwriting process, qualifying the buyer, and factors taken into account when a buyer s financial i situation ti is evaluated.

3 Introduction Loan underwriter evaluates: 1. loan applicant s overall financial situation; and 2. value of the property.

4 Introduction Underwriter tries to make sure buyer is someone who can afford loan and who is unlikely to default.

5 The Underwriting Process Underwriting involves: reviewing loan application;

6 The Underwriting Process Underwriting involves: reviewing loan application; obtaining additional information about obtaining additional information about applicant;

7 The Underwriting Process Underwriting involves: reviewing loan application; obtaining additional information about applicant; applying l i lender s qualifying i standards; d

8 The Underwriting Process Underwriting involves: reviewing loan application; obtaining additional information about applicant; applying l i lender s qualifying i standards; d verifying information provided;

9 The Underwriting Process Underwriting involves: reviewing loan application; obtaining additional information about applicant; applying l i lender s qualifying i standards; d verifying information provided; evaluating property appraisal;

10 The Underwriting Process Underwriting involves: reviewing loan application; obtaining additional information about applicant; applying l i lender s qualifying i standards; d verifying information provided; evaluating property appraisal; and making recommendation.

11 The Underwriting Process Qualifying standards Underwriting standards Minimum standards used in underwriting. Draw line between acceptable and Draw line between acceptable and unacceptable risks.

12 The Underwriting Process Qualifying standards Underwriting standards Although lenders can set their own standards, most use Fannie Mae/Freddie Mac standards for conventional loans. FHA and VA standards must be used for FHA and VA loans.

13 The Underwriting Process Automated underwriting Automated underwriting system (AUS): computer program that performs preliminary analysis of loan applications.

14 The Underwriting Process Automated underwriting Automated underwriting system (AUS): computer program that performs preliminary analysis of loan applications. Used in conjunction with traditional underwriting.

15 The Underwriting Process AU and secondary market Predominant AUS were developed by Fannie Mae and Freddie Mac. Desktop p Underwriter (Fannie Mae) Loan Prospector (Freddie Mac)

16 The Underwriting Process AU and secondary market Predominant AUS were developed by Fannie Mae and Freddie Mac. Desktop p Underwriter (Fannie Mae) Loan Prospector (Freddie Mac) B th d t d it ti l FHA Both are used to underwrite conventional, FHA, or VA loans.

17 The Underwriting Process AU and secondary market Although Fannie Mae and Freddie Mac encourage lenders to use their AU systems, they do buy traditionally-underwritten loans.

18 The Underwriting Process AU programming Programming of secondary market agency AU systems is based on performance of millions of loans. Loan performance : whether payments are made, vs. collection problems or default.

19 The Underwriting Process AU programming Programming of secondary market agency AU systems is based on performance of millions of loans. Loan performance : whether payments are made, vs. collection problems or default. Statistical analysis highlights the factors that make Statistical analysis highlights the factors that make a loan perform better.

20 The Underwriting Process AU programming Computerized analysis adds higher level of precision to traditional underwriting. Both agencies use latest information to adjust their systems. Adjustments have nationwide impact on Adjustments have nationwide impact on underwriting.

21 The Underwriting Process How AU works Underwriter enters information from loan application into AU system. System y obtains applicant s credit report. Issues a report with recommendation.

22 The Underwriting Process How AU works Recommendations in an AU report fall into three categories: risk classification, documentation classification, and appraisal i l classification.

23 The Underwriting Process How AU works Risk classification Determines level of scrutiny application should receive. Approve/Accept = meets qualifying i standards. d Refer/Caution = doesn t meet all standards, should be reviewed.

24 The Underwriting Process How AU works Risk classification If application requires further review, underwriter looks at application in traditional way. Some lenders reject Refer/Caution loans without underwriting them manually.

25 The Underwriting Process How AU works Documentation classification Indicates level of documentation underwriter needs to verify information on application.

26 The Underwriting Process How AU works Documentation classification Indicates level of documentation underwriter needs to verify information on application. Basic levels are: standard, t d d streamlined ( low-doc ), minimal ( no-doc ).

27 The Underwriting Process How AU works Documentation classification Refer/Caution = standard documentation must be underwritten manually

28 The Underwriting Process How AU works Documentation classification Refer/Caution = standard documentation must be underwritten manually Approve/Accept = streamlined or minimal depends on the application

29 The Underwriting Process How AU works Appraisal classification Recommends whether: full appraisal is appropriate, drive-by inspection is sufficient, or drive-by inspection is sufficient.

30 The Underwriting Process How AU works Appraisal classification Recommends whether: full appraisal is appropriate, drive-by inspection is sufficient, or drive-by inspection is sufficient. Based on strength of application.

31 The Underwriting Process Advantages of AU Advantages of automated underwriting over traditional underwriting: streamlines process;

32 The Underwriting Process Advantages of AU Advantages of automated underwriting over traditional underwriting: streamlines process; increases objectivity;

33 The Underwriting Process Advantages of AU Advantages of automated underwriting over traditional underwriting: streamlines process; increases objectivity; and improves i underwriting accuracy.

34 Summary The Underwriting Process Underwriting standards Automated underwriting Manual underwriting Loan performance Risk classification Documentation classification Appraisal classification

35 Evaluating Creditworthiness Qualification of a buyer involves evaluation of: Income Net worth (assets) Credit history

36 Evaluating Creditworthiness Buyer is considered creditworthy if her overall financial situation indicates she can be expected to make payments on time.

37 Income Analysis Buyer s income is starting point in determining size of loan, and how expensive a home a buyer can afford.

38 Income Analysis Characteristics of income Income has three dimensions: Quantity, Quality, and Durability.

39 Income Analysis Characteristics of income Quantity Whether there is enough monthly income to cover proposed p monthly mortgage g payment.

40 Income Analysis Characteristics of income Quality (Dependability) Income sources should be reasonably dependable, such as established employer, government agency, or interest-yielding investment account. Less dependable = lower quality.

41 Income Analysis Characteristics of income Durability (Probability of continuance) Income is durable if it can be expected to continue in future,,preferably for at least next three years.

42 Income Analysis Stable monthly income Income that meets tests of quality and durability is stable monthly income, which includes: bonuses, commissions, overtime, part-time earnings, self-employment income,

43 retirement income, alimony, child support, public assistance, and investment income.

44 Stable Monthly Income Employment income Permanent income is major income source for most home buyers.

45 Stable Monthly Income Employment income Positive employment history includes: consistency, usually 2 years in same job or field;

46 Stable Monthly Income Employment income Positive employment history includes: consistency, usually 2 years in same job or field; chances for advancement;

47 Stable Monthly Income Employment income Positive employment history includes: consistency, usually 2 years in same job or field; chances for advancement; and special i l training i or education.

48 Stable Monthly Income Employment income Commissions, overtime and bonuses Considered durable if consistent part of applicant s overall earnings pattern.

49 Stable Monthly Income Employment income Part-time or seasonal work Considered stable if applicant has held job for at least two years (part-time work), and an established earning pattern exists (seasonal work).

50 Stable Monthly Income Employment income Self-employment income Includes income from personal business, freelance, or consulting work. Underwriters consider earnings trend, training and experience and nature of business. Lenders consider this very risky income.

51 Stable Monthly Income Employment income Information on application must be verified before loan is approved.

52 Stable Monthly Income Employment income Employment verification: Verification form sent to employer,

53 Stable Monthly Income Employment income Employment verification: Verification form sent to employer, or W 2 forms for 2 years plus pay stubs for 30 W-2 forms for 2 years plus pay stubs for 30 days, with phone call to employer.

54 Stable Monthly Income Employment income Employment verification: Verification form sent to employer, or W-22 forms for 2 years plus pay stubs for 30 days, with phone call to employer. Lender may also request income tax returns for previous two years to verify earnings.

55 Stable Monthly Income Retirement income Pension and social security payments are usually dependable and durable.

56 Stable Monthly Income Retirement income Pension and social security payments are usually dependable and durable. Lenders can t discriminate against applicants on basis of age. Life expectancy can be considered.

57 Stable Monthly Income Investment income Dividends or interest may be counted as part of stable monthly income.

58 Stable Monthly Income Investment income Dividends or interest may be counted as part of stable monthly income. Underwriter calculates an average of investment income for previous two years.

59 Stable Monthly Income Rental income If a stable pattern can be verified, rental income is considered stable monthly income. Applicant may have to show gross earnings and operating expenses for previous two years.

60 Stable Monthly Income Rental income Many unpredictable factors affect rental income: emergency repairs, vacancies, and tenants who don t pay.

61 Stable Monthly Income Rental income Many unpredictable factors affect rental income: emergency repairs, vacancies, and tenants who don t pay. Underwriter includes only a percentage of verified Underwriter includes only a percentage of verified income to leave a margin for error.

62 Stable Monthly Income Rental income Any negative rental income is treated as a liability by the underwriter.

63 Stable Monthly Income Maintenance, alimony, child support Considered stable income sources only if it appears payments will be made reliably. Depends on: whether payments are required by court decree, how long payments have been made, financial/credit status of ex-spouse, and ability to compel payment.

64 Stable Monthly Income Maintenance, alimony, child support Lenders usually require: copy of court decree, and proof of receipt of payments.

65 Stable Monthly Income Maintenance, alimony, child support Lenders usually require: copy of court decree, and proof of receipt of payments. Child support no longer counts when child reaches mid-teens.

66 Stable Monthly Income Maintenance, alimony, child support Applicants may not want to list these as sources of income if ex-spouse is hostile or uncooperative. Equal Credit Opportunity Act prevents lenders from asking if applicants are divorced or requiring them to disclose alimony or child support.

67 Stable Monthly Income Public assistance Equal Credit Opportunity Act also prohibits lenders from discriminating on the basis of an applicant receiving public assistance.

68 Stable Monthly Income Unacceptable types of income Income that usually doesn t count as stable monthly income: wages g from temporary job,

69 Stable Monthly Income Unacceptable types of income Income that usually doesn t count as stable monthly income: wages g from temporary job, unemployment compensation,

70 Stable Monthly Income Unacceptable types of income Income that usually doesn t count as stable monthly income: wages g from temporary job, unemployment compensation, and contributions tib ti from family members.

71 Stable Monthly Income Temporary employment Income from temporary employment is never classified as stable monthly income.

72 Stable Monthly Income Unemployment compensation Unemployment compensation rarely treated as stable income because eligibility usually lasts for a specified number of weeks. If applicant can show (through tax returns) that it s a If applicant can show (through tax returns) that it s a regular part of his income, some lenders are willing to count it.

73 Stable Monthly Income Income from family members Underwriters usually only consider earnings of the head of household. But if borrower s family member is listed as a co- borrower, that person ss income is also considered.

74 Calculating Stable Monthly Income Underwriter converts all earnings into monthly earnings.

75 Calculating Stable Monthly Income Underwriter converts all earnings into monthly earnings. Example: Glenda is paid $14.50/hour, and works 40 per week. $ = $580 $ = $30,160 $30, = $2,513

76 Calculating Stable Monthly Income Nontaxable income Underwriter uses gross income figures without subtracting taxes, when calculating stable monthly income.

77 Calculating Stable Monthly Income Nontaxable income Certain types of income are exempt from taxation. child support, disability payments, and some public assistance.

78 Calculating Stable Monthly Income Nontaxable income Certain types of income are exempt from taxation. child support, disability payments, and some public assistance. Underwriter may take this into account by grossing up income (adding amount of gross taxable income represented ese by payments).

79 Income Ratios To measure adequacy of applicant s monthly income, underwriters use income ratios. Difficult for borrower to make payments if: Borrower Expenses > % of Monthly Income

80 Income Ratios Two types of income ratios: Debt to income ratio

81 Income Ratios Two types of income ratios: Debt to income ratio Housing expense to income ratio

82 Income Ratios Debt to income ratio Measures proposed monthly mortgage payment and any other regular debt payments against monthly income.

83 Income Ratios Housing expense to income ratio Measures monthly mortgage payment alone against monthly income.

84 Income Ratios In most loan programs, maximum income ratios are treated as guidelines, not hard-and-fast limits.

85 Income Ratios In most loan programs, maximum income ratios are treated as guidelines, not hard-and-fast limits. Lender may approve loan if sufficient compensating factors make up for weakness in income.

86 Income Ratios Recently, lenders have considered debt-to-housing gap ratio. Measures difference between debt to income ratio and housing expense to income ratio.

87 Income Ratios Cosigners Cosigner helps borrower qualify by sharing responsibility for loan. Primary borrower and cosigner have joint and several liability for loan. Court can order either one of them to pay Court can order either one of them to pay loan balance.

88 Income Ratios Cosigners Cosigner must have acceptable income, assets, and credit reputation. Underwriter evaluates cosigner, just like primary borrower.

89 Summary Creditworthiness and Income Analysis Creditworthy Income Quality Quantity Durability Stable monthly income Unacceptable income Income ratios Cosigners

90 Net Worth Individual s net worth is determined by subtracting personal liabilities from total personal assets. Indicates ability to manage financial affairs. Must have enough liquid assets to close Must have enough liquid assets to close transaction.

91 Net Worth Funds for closing Liquid assets include cash and assets that can be easily converted into cash.

92 Net Worth Funds for closing Liquid assets include cash and assets that can be easily converted into cash. Applicant must have enough to cover: cash downpayment, closing l i costs, and other home expenses.

93 Net Worth Funds for closing Applicant may be required to have reserves left over after closing, sufficient to cover a certain number of mortgage payments. Shows applicant can handle financial emergencies.

94 Net Worth Assets Almost any assets may help a loan applicant. May include: real estate, automobiles, furniture, f jewelry, stocks/bonds, or life insurance policy.

95 Net Worth Bank Accounts To verify funds an applicant has in bank accounts: verification of deposit form sent to the bank, or bank statements for 3 months.

96 When reviewing returned verification information, underwriter asks: Does information conform to statements in loan application?

97 When reviewing returned verification information, underwriter asks: Does information conform to statements in loan application? Does applicant have enough money in bank to meet purchase expenses?

98 When reviewing returned verification information, underwriter asks: Does information conform to statements in loan application? Does applicant have enough money in bank to meet purchase expenses? Has bank account been opened only recently (last 3 months)?

99 When reviewing returned verification information, underwriter asks: Does information conform to statements in loan application? Does applicant have enough money in bank to meet purchase expenses? Has bank account been opened only recently (last 3 months)? Is present balance notably higher than average p y g g balance?

100 When reviewing returned verification information, underwriter asks: Does information conform to statements in loan application? Does applicant have enough money in bank to meet purchase expenses? Has bank account been opened only recently (last 3 months)? Is present balance notably higher than average balance? If account is claimed to be source of earnest If account is claimed to be source of earnest money, is balance high enough?

101 Net Worth Bank Accounts Borrower may include funds from loan secured by an asset such as: car, stock, certificate t of deposit, life insurance policy, or other real estate.

102 Net Worth Real estate for sale If applicant is selling another property to raise cash, net equity in property can be counted as a liquid asset.

103 Net Worth Real estate for sale If applicant is selling another property to raise cash, net equity in property can be counted as a liquid asset. Net Equity = Market Value (Liens + Selling Expenses)

104 Net Worth Real estate for sale If equity is exclusive or main source of money for purchase of new home, lender won t fund loan until old home has been sold.

105 Net Worth Real estate for sale If equity is exclusive or main source of money for purchase of new home, lender won t fund loan until old home has been sold. Copy of settlement statement is usually required.

106 Net Worth Real estate for sale Sometimes new home is ready to close before old home is sold. Buyers may want to apply for swing loan to cover closing.

107 Net Worth Other real estate Some applicants own real estate they aren t planning on selling. It s considered an asset and should be considered in loan application. Only equity contributes to net worth.

108 Net Worth Liabilities Applicant s personal liabilities are subtracted from total value of assets to calculate net worth.

109 Net Worth Liabilities Applicant s personal liabilities are subtracted from total value of assets to calculate net worth. Liabilities include: credit card and charge account balances, installment i t t debts, taxes owed, and liens against real estate owned.

110 Net Worth Gift funds Rules regarding gift funds varies from one loan program to another. Most programs limit how much of downpayment and closing costs may be covered by gift funds.

111 Net Worth Gift funds Generally, lenders require: gift letter stating that funds don t have to be repaid; and funds deposited in applicant s account.

112 Summary Net Worth Liquid q assets Reserves Assets Bank accounts Real estate for sale Net equity Swing loan Liabilities Gift funds

113 Credit Reputation Lenders rely on credit reports to evaluate loan applicant s credit reputation. Derogatory information on report could mean denial of loan.

114 Credit Reputation Credit reports Personal credit report covers 7 years of information about an individual s: loans, credit purchases, and debt d repayment.

115 Credit Reputation Credit reports Personal credit report covers 7 years of information about an individual s: loans, credit purchases, and debt d repayment. Utility, medical bills, etc. aren t listed unless they are turned over to collection o agency.

116 Credit Reputation Credit reports Credit reporting agencies are private companies. Three major credit agencies in U.S.: Equifax, Experian (formerly TRW), and TransUnion.

117 Credit Reputation Credit reports Credit information important to underwriter includes: length of credit history, payment record, derogatory credit incidents, and credit scores.

118 Credit Reputation Length of credit history Credit history can refer to someone s credit reputation or duration of applicant s experience with credit. Applicant should have 2 years of credit history.

119 Credit Reputation Payment record Each account listed on credit report has payment record showing whether payments have been made on time. Late payments are shown as 30 days, 60 days, or Late payments are shown as 30 days, 60 days, or 90 days overdue.

120 Credit Reputation Payment record Underwriters view chronic late payments as sign applicant is financially overextended. Spotless p payment record not necessary.

121 Credit Reputation Major derogatory incidents Negative information on credit report includes: slow payment, charge-offs, collections, repossessions, judgments, foreclosures, and bankruptcies.

122 Credit Reputation Major derogatory incidents Charge-off Tax code allows creditors to write off debt that hasn t had payment in 6 months.

123 Credit Reputation Major derogatory incidents Charge-off Tax code allows creditors to write off debt that hasn t had payment in 6 months. Doesn t relieve debtor of liability.

124 Credit Reputation Major derogatory incidents Collections If unpaid bills are turned over to collection agencies, they will appear on a credit report.

125 Credit Reputation Major derogatory incidents Repossessions If someone fails to make payments, a creditor can repossess the collateral property. p

126 Credit Reputation Major derogatory incidents Judgments When someone loses a lawsuit, court may order her to pay money (damages) to the person who sued.

127 Credit Reputation Major derogatory incidents Foreclosures Not surprisingly, lenders don t look favorably upon real estate foreclosures.

128 Credit Reputation Major derogatory incidents Bankruptcy Bankruptcy on applicant s credit report is also taken very seriously.

129 Credit Reputation Credit scores Credit reporting agencies calculate individual credit scores. Scoring models are based on statistical analysis of large numbers of mortgages.

130 Credit Reputation Credit scores Credit reporting agencies calculate individual credit scores. Scoring models are based on statistical analysis of large numbers of mortgages. Predict likelihood of default. Determine appropriate level of review.

131 Credit Reputation Credit scores Two most widely used types of credit scores: FICO bureau scores, and MDS bankruptcy scores.

132 Credit Reputation Credit scores FICO scores Range from 400 to over 800, and are used more often than MDS bankruptcy scores.

133 Credit Reputation Credit scores FICO scores Range from 400 to over 800, and are used more often than MDS bankruptcy scores. A high score (over 680) is a good sign.

134 Credit Reputation Credit scores MDS scores Range from zero to over 1,000. A high score (over 550) is a bad sign.

135 Credit Reputation Credit scores Underwriters use credit scores to determine level of review applied to applicant s credit history. Good score = basic review Bad score = in-depth review

136 Credit Reputation Credit scores Several other factors can negatively impact credit score, such as: chronic late payments, maintaining high balance on credit card, and applying for too much credit.

137 Credit Reputation Obtaining credit information Prospective buyers should look at their credit reports and scores before applying for mortgage. May y have incorrect information.

138 Credit Reputation Explaining credit problems If underwriter is convinced that past problems don t reflect loan applicant s attitude towards credit, buyer may get loan.

139 Credit Reputation Explaining credit problems Letter explaining negative credit report should: state reason for problem;

140 Credit Reputation Explaining credit problems Letter explaining negative credit report should: state reason for problem; identify problem occurred during a specific identify problem occurred during a specific period;

141 Credit Reputation Explaining credit problems Letter explaining negative credit report should: state reason for problem; identify problem occurred during a specific period; show h problem no longer exists;

142 Credit Reputation Explaining credit problems Letter explaining negative credit report should: state reason for problem; identify problem occurred during a specific period; show h problem no longer exists; highlight good credit before and since;

143 Credit Reputation Explaining credit problems Letter explaining negative credit report should: state reason for problem; identify problem occurred during a specific period; show h problem no longer exists; highlight good credit before and since; provide documentation from a third party;

144 Credit Reputation Explaining credit problems Letter explaining negative credit report should: state reason for problem; identify problem occurred during a specific period; show h problem no longer exists; highlight good credit before and since; provide documentation from a third party; and not tblame creditors.

145 Other Factors in Underwriting Loan type Loan type means whether loan is a fixed-rate, adjustable-rate, or some other type. Borrowers default more on ARMS and loans that involve changes in payments.

146 Summary Credit Reputation Credit reports Credit history Payment record Derogatory incidents Credit scores FICO bureau scores MDS bankruptcy scores Explanation letter

147 Other Factors in Underwriting Repayment period Length of repayment period affects qualifying process because of its impact on size of monthly payments. Shorter payment period, larger payments.

148 Other Factors in Underwriting Owner-occupancy Investor loans have much higher default rate than loans to owner-occupants.

149 Other Factors in Underwriting Property type Single-family homes appreciate much more and more reliably than: manufactured homes, condominium units, and other types of residential property.

150 Risk-Based Loan Pricing Risk-based pricing is charging borrowers different interest rates and loan fees depending on their credit risk.

151 Risk-Based Loan Pricing Risk-based pricing is charging borrowers different interest rates and loan fees depending on their credit risk. Poor credit risk = high interest rates Good credit risk = low interest rates

152 Risk-Based Loan Pricing Prime lenders have used average cost pricing or par rate pricing. All approved borrowers are charged same interest rate and fees. Those who don t meet lender standards Those who don t meet lender standards are denied loan.

153 Risk-Based Loan Pricing Risk-based pricing is established in prime lending. AU is one of the main reasons.

154 Risk-Based Loan Pricing Risk-based pricing is established in prime lending. AU is one of the main reasons. Advantage is that fewer applicants are denied financing. F i b d dit i k d t Fairer because good credit risks don t subsidize poor credit risks.

155 Risk-Based Loan Pricing On other hand, buyers who don t qualify for best rates may be priced out of market. May y make loan shopping confusing. Lenders can t advertise one interest rate (or APR).

156 Summary Other Factors and Risk-Based Pricing Loan type Repayment period Own-occupancy Investor loan Property type Risk-based pricing Average cost pricing