Chapter 8Chapter 8

Underwriting The Underwriting The Residential Mortgage LoanResidential Mortgage Loan

Underwriting is an integral part Underwriting is an integral part of the mortgage lending of the mortgage lending process, regardless of the type process, regardless of the type of loan or the type of property of loan or the type of property securing the mortgage. securing the mortgage. Although similarities exist in the Although similarities exist in the underwriting of the different underwriting of the different types of residential mortgage types of residential mortgage loans (conventional, FHA, VA) loans (conventional, FHA, VA) the differences are more the differences are more procedural and not of great procedural and not of great significance.significance.

Understanding Risk:Understanding Risk: The underwriting involved to determine the risk The underwriting involved to determine the risk

requires the gathering and analysis of much requires the gathering and analysis of much information about both the applicant and the information about both the applicant and the real estate that will secure the mortgage loan. real estate that will secure the mortgage loan. On any single residential loan, three separate On any single residential loan, three separate underwriting reviews could occur at various underwriting reviews could occur at various stages of the mortgage lending cycle by the stages of the mortgage lending cycle by the following parties:following parties:• Mortgage LenderMortgage Lender• Mortgage Insurer (Guarantor)Mortgage Insurer (Guarantor)• Permanent InvestorPermanent Investor

A A Mortgage Lender Mortgage Lender analyzes the risk and analyzes the risk and determines whether to lend funds at a certain determines whether to lend funds at a certain interest rate to a borrower for a period of time interest rate to a borrower for a period of time secured by a certain piece of real estate.secured by a certain piece of real estate.

A A Mortgage Insurer Mortgage Insurer determines if mortgage determines if mortgage insurance is to be written or a guarantee insurance is to be written or a guarantee made based on the loan as submitted.made based on the loan as submitted.

A A Permanent Investor Permanent Investor determines if the determines if the mortgage or mortgages as submitted will be mortgage or mortgages as submitted will be purchased.purchased.

Underwriting Guidelines:Underwriting Guidelines:

No single uniform set of underwriting No single uniform set of underwriting guidelines exists for all residential mortgage guidelines exists for all residential mortgage loans. To a great extent, the underwriting loans. To a great extent, the underwriting guidelines of both Fannie Mae and Freddie Mac guidelines of both Fannie Mae and Freddie Mac are the core standards that most lenders are the core standards that most lenders attempt to follow. Even those lenders who attempt to follow. Even those lenders who don’t intend to sell loans to theses two don’t intend to sell loans to theses two secondary mortgage market players should secondary mortgage market players should attempt to follow these well-conceived attempt to follow these well-conceived underwriting guidelines.underwriting guidelines.

Underwriting is an art not a science.Underwriting is an art not a science.

Loan-to-Value Ratios:Loan-to-Value Ratios:

The lower the LTV ratio the safer the The lower the LTV ratio the safer the loan is for the lender. The reason is loan is for the lender. The reason is that the lower the LTV ratio, the that the lower the LTV ratio, the higher the equity investment the higher the equity investment the borrower will have in the property and borrower will have in the property and thus the more that borrower has to thus the more that borrower has to lose.lose. ____________MortgageMortgage__AmountAmount___________ =LTV___________ =LTV

Lesser of Sales Price or Lesser of Sales Price or Appraised ValueAppraised Value

Down Payment (Equity):Down Payment (Equity): The money for the down payment The money for the down payment

(equity) can come from any liquid (equity) can come from any liquid investment sourceinvestment source

The existence and history of these The existence and history of these funds should be established by a funds should be established by a Verification of Deposit (VOD).Verification of Deposit (VOD).• When was the account opened?When was the account opened?• How long have the funds been there?How long have the funds been there?• In what name(s) is it held?In what name(s) is it held?

Income Ratios:Income Ratios: The most important test of whether The most important test of whether

an applicant can afford a particular an applicant can afford a particular mortgage loan is by computing the mortgage loan is by computing the various income ratios.various income ratios.

Borrower Income:Borrower Income: Income Sources include these:Income Sources include these:

• Regular wagesRegular wages• Part-time employmentPart-time employment• Working spouseWorking spouse• RentalsRentals• Alimony or child supportAlimony or child support• CommissionsCommissions• Public AssistancePublic Assistance

The underwriter must judge that The underwriter must judge that the income is likely to continue. the income is likely to continue. The income must be verifiable.The income must be verifiable.

• Self-employmentSelf-employment• BonusesBonuses• Dividends or Dividends or

interestinterest• Retirement annuityRetirement annuity• Social securitySocial security

Estimating Housing Expense:Estimating Housing Expense:

Principal and interest on the Principal and interest on the mortgage being applied for.mortgage being applied for.

Mortgage insurance (if any).Mortgage insurance (if any). Property TaxesProperty Taxes Hazard InsuranceHazard Insurance Condominium or cooperative Condominium or cooperative

homeowners association dues (if homeowners association dues (if applicable)applicable)

Other Obligations:Other Obligations:

Borrowers will have other obligations, Borrowers will have other obligations, examples include:examples include:• auto loans, auto loans, • credit card accounts, credit card accounts, • other mortgage debts,other mortgage debts,• or alimony and child support payments.or alimony and child support payments.

Housing Expense RatioHousing Expense Ratio Housing ExpensesHousing Expenses

Borrower’s IncomeBorrower’s Income<< 28% 28%

(CONVENTIONAL LOAN)(CONVENTIONAL LOAN) Total Obligations RatioTotal Obligations Ratio

Total ObligationsTotal ObligationsBorrower’s IncomeBorrower’s Income

< < 36% 36% (CONVENTIONAL LOAN)(CONVENTIONAL LOAN)

Higher Ratios may be justified Higher Ratios may be justified by mitigating factors, such as:by mitigating factors, such as: Demonstrated ability of an applicant to Demonstrated ability of an applicant to

allocate a higher percent of gross income to allocate a higher percent of gross income to housing expenseshousing expenses

Larger down payment than normalLarger down payment than normal Demonstrated ability of an applicant to Demonstrated ability of an applicant to

accumulate savings and maintain a good accumulate savings and maintain a good credit ratingcredit rating

A large net worthA large net worth Potential for increased earnings because of Potential for increased earnings because of

education or professioneducation or profession

FHA Ratios are:FHA Ratios are: 29 percent for the mortgage payment ratio29 percent for the mortgage payment ratio 41 percent for the total debt ratio41 percent for the total debt ratio

VA Ratios are:VA Ratios are: The VA uses a modified residual method in qualifying a veteran for a mortgage loan, and this result is then The VA uses a modified residual method in qualifying a veteran for a mortgage loan, and this result is then

double-checked against a total debt-to-income ratio of 41 percent. double-checked against a total debt-to-income ratio of 41 percent.

Loan ClassificationsLoan Classifications

Conventional MortgagesConventional Mortgages Insured conventional mortgagesInsured conventional mortgages FHA insured mortgagesFHA insured mortgages VA guaranteed mortgagesVA guaranteed mortgages

“Sharing Default Risk”“Sharing Default Risk”

Conventional Mortgages:Conventional Mortgages: Not insured or guaranteed by federal agencyNot insured or guaranteed by federal agency Maximum LTV Ratio of 80% (occasionally Maximum LTV Ratio of 80% (occasionally

higher)higher) Private mortgage insurance (PMI) usually Private mortgage insurance (PMI) usually

required on purchases with down payments required on purchases with down payments <20%<20%

PMI enables lenders to settle for low (perhaps PMI enables lenders to settle for low (perhaps as low as 5%) down payments.as low as 5%) down payments.

Most PMI policies cover top 20-25% of the Most PMI policies cover top 20-25% of the mortgage.mortgage.

Advantages of PMIAdvantages of PMI Borrower can buy house that might not pass Borrower can buy house that might not pass

VA or FHA inspectionVA or FHA inspection Allows small down paymentAllows small down payment Premiums are lower than FHA because it Premiums are lower than FHA because it

doesn’t cover entire mortgagedoesn’t cover entire mortgage Processed quicker than FHAProcessed quicker than FHA PMI can be canceled when LTV < 80%PMI can be canceled when LTV < 80% Rates are determined by marketRates are determined by market PMI allows lender to sell mortgage in PMI allows lender to sell mortgage in

secondary marketsecondary market

Credit HistoryCredit History

Credit Report:Credit Report:• Identifying sectionIdentifying section• Info on age, marital status, dependents, Info on age, marital status, dependents,

employment, etc... - applicant and co-employment, etc... - applicant and co-applicantapplicant

• Credit recordCredit record• Public Records dataPublic Records data

The Closing ProcessThe Closing Process

•The purpose of the closing is to make The purpose of the closing is to make final settlement between the buyer and final settlement between the buyer and seller for costs, fees, and prorations seller for costs, fees, and prorations associated with the real estate associated with the real estate transaction prior to the transfer of title, transaction prior to the transfer of title, and to finalize the loan agreement and to finalize the loan agreement between the buyer/borrower and the between the buyer/borrower and the lender. lender.

Fees and ExpensesFees and Expenses Financing costs:Financing costs:

1.1. Loan application feeLoan application fee2.2. Credit report feeCredit report fee3.3. Loan origination feeLoan origination fee4.4. Lender’s attorney’s feesLender’s attorney’s fees5.5. Property appraisal feeProperty appraisal fee6.6. Fees for property surveyFees for property survey7.7. Fees for preparation of loan Fees for preparation of loan

amortization scheduleamortization schedule8.8. Loan discount pointsLoan discount points9.9. Prepaid interestPrepaid interest

Prorations, Escrow Costs, and Prorations, Escrow Costs, and Payments to Third PartiesPayments to Third Parties

Property Tax, Prorations, and Escrow Property Tax, Prorations, and Escrow AccountsAccounts

Mortgage Insurance and Escrow AccountsMortgage Insurance and Escrow Accounts Hazard Insurance and Escrow AccountsHazard Insurance and Escrow Accounts Hazard Insurance and Escrow AccountsHazard Insurance and Escrow Accounts Mortgage Cancellation Insurance and Mortgage Cancellation Insurance and

Escrow AccountsEscrow Accounts Title Insurance, Lawyer’s Title OpinionTitle Insurance, Lawyer’s Title Opinion Release FeesRelease Fees Attorney’s FeeAttorney’s Fee Pest Inspection CertificatePest Inspection Certificate Real Estate CommissionReal Estate Commission

Statutory CostsStatutory Costs

Recording fees. Fees paid for Recording fees. Fees paid for recording of the mortgage and note recording of the mortgage and note in the public records.in the public records.

Transfer tax. A tax usually imposed Transfer tax. A tax usually imposed by the county on all real estate by the county on all real estate transfers.transfers.

Requirements under the Real Requirements under the Real Estate Settlement and Procedures Estate Settlement and Procedures

Act (RESPA)Act (RESPA) The essential aspects of RESPA fall into The essential aspects of RESPA fall into

seven areas that are used here to seven areas that are used here to facilitate discussion:facilitate discussion:

1.1. Consumer informationConsumer information

2.2. Advance disclosure of settlement costsAdvance disclosure of settlement costs

3.3. Title insurance placementTitle insurance placement

4.4. Prohibition of kickbacks and referral feesProhibition of kickbacks and referral fees

5.5. Uniform settlement statementUniform settlement statement

6.6. Advance inspection of uniform settlement Advance inspection of uniform settlement statementstatement

7.7. Escrow depositEscrow deposit

Settlement StatementSettlement StatementI. Amount Due from Buyer:I. Amount Due from Buyer: II. Amount Due to Buyer:II. Amount Due to Buyer:

(A) Purchase Price(A) Purchase Price $76,700.0$76,700.000

Sale PriceSale Price $76,700.00$76,700.00

Plus: Settlement ChargesPlus: Settlement Charges

County Tax ProrationCounty Tax Proration2,909.692,909.69

615.76615.76Plus: County tax prorationPlus: County tax proration 615.76615.76

Less: earnest MoneyLess: earnest Money

Mortgage LoanMortgage Loan1,000.001,000.00

61,360.0061,360.00Less: Payoff of existing loan Less: Payoff of existing loan

Settlement charges*Settlement charges*21,284.15 21,284.15

4,607.004,607.00

Net Amount Due from BuyerNet Amount Due from Buyer $17,865.4$17,865.455

Net amount due to sellerNet amount due to seller $51,424.61$51,424.61

Buyer’s Share of Settlement Buyer’s Share of Settlement Changes:Changes:

*Seller’s Hare of Settlement *Seller’s Hare of Settlement Charges:Charges:

Loan origination feeLoan origination fee $614.00$614.00 *Broker commission*Broker commission $4,602.00$4,602.00

Loan DiscountLoan Discount 614.00614.00 *Recording fee*Recording fee 5.005.00

Appraisal feeAppraisal fee 125.00125.00

Credit reportCredit report 45.0045.00

Mortgage insurance Application fee Mortgage insurance Application fee 50.0050.00

Interest (7 days @ $15.55)Interest (7 days @ $15.55) 108.85108.85

Homeowners insuranceHomeowners insurance 552.00552.00

2 months premium-escrow2 months premium-escrow 92.0092.00

2 months property tax-escrow2 months property tax-escrow 132.84132.84

Title insurance (lender)Title insurance (lender) 100.00100.00

Recording feeRecording fee 31.0031.00

Closing feeClosing fee 75..0075..00

Title insurance Title insurance 350.00350.00

Pest inspectionPest inspection 20.0020.00

TotalTotal $2,909.60$2,909.60 TotalTotal $4,607.00$4,607.00