Transcript Chapter 13
REAL ESTATE FINANCE PRESENTATION 8 Chapter 13 Qualifying the Borrower 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. TQ The individual who conducts this process is called an UNDERWRITER. TQ The primary concern of the underwriter is to minimize the amount of the lender’s risk. I. FHLMC/FNMA Underwriting Standards 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.” TQ • 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. A. INCOME • 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 TQ • DEBT SERVICE = DEBT TO INCOME TQ DEBT RATIOS MADE TO EXCEED? • 28/31 means i.e., min down max LTV – 20% Down Payment – 80% Loan To Value • What about more down??? – 40% Down Payment – 60% LTV – 50% Down / 50% LTV • DTI RATIO CAN BE EXCEEDED UP TO 55% TQ WHAT??? • YOU heard right – Why can rules be broken? – Risk Factor is decreased – Really? You gonna’ put 50% down • You probably have even more reserves • You probably have super FICO score • You DEFININTELY don’t want to lose investment!! What about higher FICO? • Better credit scores mean higher DTI probably – A little better probably a little higher – A lot better, a bit more higher probably • Still more $$ is a better risk factor • Credit scores can go up and down • $$$ Talks NOTE: THIS IS LIKELY, NOT GUARANTEED!!! 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. • IT’S ALL FULL DOC!!!!! TQ – Quality – Durability – Bonuses, Commissions, and Part-Time Earnings – Overtime – Unemployment (if regular) and AFDC – Alimony, Child Support, or Maintenance – Income from Other Family Members – Self-Employment Income – Co-mortgagor – Rental Income – Verifying Income FULL DOC – WAS’ DAT? • It means all income and assets and everything else will be backed up with: TQ – – – – – – – Bank statements Paystubs, W-2’s, 1099’s, 1040’s, etc. Audited P & L & Bal. Sheet (Year To Date) Divorce settlements (for $$) Appraisals Rent Surveys You name it! 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) Monthly=HOURLY X 40 X 4.333 or YEARLY / 12 • Example: Hourly Wage: $20.00 x 40 x 4.333 = 3466.67 Weekly Income: $20.00 x 40 = $800 Annual Income: $800 x 52 = $41,600 Monthly Income: $41,600 ÷ 12 = $3,466.67 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, and/or Paystubs for 30 days TQ • Annual income for 2 years, i.e., 2 years 1040’s • 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. 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. TQ • 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. TQ 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. B. NET WORTH • According to Fannie Mae, “accumulation of • • net worth is a strong indication of credit worthiness.” TQ 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. 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 (PITIM) after making the down payment and paying all closing costs. AUTOMATED U/W (DU-Desktop Underwriter) findings will be the guideline ultimately. TQ 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. INVESTMENT PROPERTY RESERVES • Investment Property = Non Owner Occ. • 6 months reserves for rental TQ – And for each rental with a loan on it – Yep 3 rentals = 18 months reserves • 2 months reserves for residence & any 2nd home (owner occupied – vacation home) 2. Verification of Assets • Included in every loan application is a section devoted to assets. TQ • The underwriter will take whatever steps are necessary to verify the nature and value of assets held by the borrower. • LIQUID ASSETS • NON-LIQUID ASSETS 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. Used less often now, than bank statements TQ 4. (Previously) Alternative, now the Usual Verification Method TQ Lenders may use an alternative method of verifying deposits: the borrower may submit the original bank statements for the previous two months to verify sufficient cash for closing. • 2 months per account being verified 5. Financial Statement Self Employed or Multiple Incomes • 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. 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, SUBJECT TO closing that sale! 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. TQ Equity is what the buyer should receive from the sale of the property. 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 OR retirement fund. 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 WILL 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. There is a form for this!! Also, evidence of donor’s ability to give will be required!! TQ 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. TQ • 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. Figure 13-7 1. Explaining Derogatory Credit • LESS IMPORTANT NOW THAN EVER DUE TO FICO’s TQ • 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. 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. 3. Illegal Discrimination • A borrower must be of legal age (18) before • • • he or she can qualify for a loan; after that, an applicant’s age is not a valid reason for rejecting a loan. NO MATTER HOW OLD WE ARE!!! TQ Your life expectancy is NOT a factor!!!!! 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. TQ TQ TQ Figure 13-8 Qualifying a borrower 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 FNMA (FANNIE MAE) and FHLMC (FREDDIE MAC). Chapter 14 Qualifying the Property Valuation Broker Price Opinion Appraisal I. The Lender’s Perception of Value APPRAISAL Lender’s Perception of Value • Lenders utilize Licensed and Certified Appraisers to provide a professional opinion of market value for each residence they loan upon. • By both state and federal law appraisers are required to provide an unbiased and independent analysis of the property. TQ • MARKET VALUE is the price paid by a typical buyer; it is based on the analysis of a group of actual sales that occurred in the marketplace. • It is this true market value that a lender seeks, because if a foreclosure is ever necessary, the lender has some assurance that the property can be sold for an amount that can enable them to recover most, if not all, of their investment. A. LTV AND MAXIMUM LOAN AMOUNT • Loans are generally made at a loan-to-value ratio of from 80% to 90% of the value of the property. Example: • $180,000.00 Sales Price • $150,000.00 Appraised Value • $150,000.00 Appraised Value • x .80 Loan to Value Ratio • $120,000.00 Maximum Loan • In the example, the maximum loan is predicated on the lower appraised value, not the higher sales price. • If the lender were to base the loan on the higher of the two figures, it would be loaning an amount that would be 96% of the appraised market value. B. ESTIMATING MARKET VALUE • It is not necessary for agents and loan officers • • to be able to appraise properties, BUT it is NECESSARY TO DO A VALUATION!! TQ However, it is helpful to understand the mechanics of the appraisal process and to know something about the reasoning and logic that underlies many of the appraiser’s conclusions. For real estate agents, an understanding of how lenders and their appraisers perceive value will enable them to write and arrange financing for sales that will hold together. II. Market Approach This is the only way value is determined. Yes, appraisals have “replacement value” or “cost of construction” BUT the value that is used is MARKET VALUE! TQ Market Approach • The market approach to value is the most easily understood by the • • • • layman. The MARKET APPROACH involves a comparison of the property being appraised against other similar properties in the same neighborhood that have recently sold or are currently being offered for sale AKA “COMPS”. TQ Appraisers know that no informed buyer who is acting free of pressure will pay more for a particular property than he or she would have to pay for an equally desirable substitute property. An informed seller is not likely to sell for less than is necessary, and if he or she is objective, the selling price will be based on the results of recent sales in the neighborhood. The property sales that appraisers actually use are those that have closed escrow. A. IDENTIFYING LEGITIMATE COMPARABLES • When utilizing the market approach, the appraiser must be certain that the sales used as a basis for comparison are, in fact, relevant in terms of the factors that have the most impact on value 1. Metropolitan Statistical Areas • A METROPOLITAN STATISTICAL AREA is an • • area with a core city population of 50,000 people and the area surrounding it. The information obtained from these areas is considered to be significant to business, industry and consumer groups. Bar graphs may be combined with a frequency curve to provide what is known as a HISTOGRAM. • FREQUENCY CURVES • BELL CURVE 2. Multiple Regression Analysis • Another tool consists of the use of MULTIPLE • REGRESSION ANALYSIS, which is a statistical procedure that attempts to assess the relationship between a dependent variable and two or more independent variables. THIS IS ALSO KNOW AS “FANCY B.S.” 3. Automated Valuation Models • Currently, NOT a popular tool for the selection of comparable sales, the AUTOMATED VALUATION MODEL (AVM), which is a computer generated valuation report, THAT WAS the darling of the lending industry FOR 5 MINUTES! TQ • Many residential lenders accept AVM reports in lieu of traditional appraisals for both first and second mortgages. • An AVM can review and select from hundreds of properties within seconds. • If the AVM is combined with a regression analysis program it can provide a bottom line value in seconds. AVMs (cont.) • Well, it turns out that most AVMs are only accurate • • • • about 65% of the time. All economic and appraisal modeling programs require proper calibration by the user. In addition, the raw data put into many models is often unverified and incorrect. For example, most county data is anywhere from 10-15 years old and may not include homeowner upgrade information. The AVM program assumes that every residence in your area is of the same quality and condition. The question might be asked: “Why do we need an appraiser?” 4. Appraiser Assisted AVMs • To try to answer these problems the industry • • • has developed the APPRAISER ASSISTED AUTOMATED VALUATION MODEL (AAAVM). These programs are modified to allow an appraiser to manually input information, make some adjustments, and do minimal calibration. Also, the appraiser signs off on the result which takes care of who is liable for the accuracy of the AVM. NOT A TQ ISSUE!!!! NOT TQ……. 5. Sale Date of the Comparable Sale • The sale should be recent—within the past six months, if possible. • Recent sales are used because they most accurately reflect what is occurring in the current market and do not require adjustments for time. BROKER PRICE OPINIONS • “Cheap” appraisals that lenders order from us • brokers who want to make $20 an hour (or less) on average. TQ Use comps 3 mos or less old, within 1 to 3 miles (depending on rural, urban, or suburban…which is flexible), within 20 to 25% of the GLA (gross living space) and a reasonable variation of lot size, and age construction (year built) TQ BROKER VALUATION • Generally do your own “BPO” (you just don’t get paid for it until the listing sells • Used to estimate value of a listing • Follow same guidelines • Aka “Comparative Market Analysis” • All of the above are TQ issues. 6. Location of the Comparable Sale • Comparables should be selected from the • • neighborhood of the subject property. In the absence of any legitimate comparable sales in the neighborhood, the appraiser can select comparables from nearby similar neighborhoods. TQ Care must be taken that the properties and the neighborhoods have similar physical and demographic characteristics. 7. Physical Characteristics • To qualify as a comparable, a property should • have physical characteristics that are essentially similar to the subject property. TQ That is, for example, compare two story homes to two story homes…dome homes t dome homes (oops, this is known as a “nonconforming construction”)…seen many of them around? TQ 8. Terms of Sale • With the increase of seller participation in financing • • • • today, the terms of sale have become much more of a factor when estimating value. Buyers have demonstrated a readiness that often borders on foolishness to pay inflated prices for housing. Often, eager sellers offer to pay a % of the sales price in “closing costs or pre-paid expenses” while adjusting the price of the house upwards to recover the difference in interest. TOTALLY LEGAL, but has limits. TQ The appraiser is required to research the terms of sale of comparables to determine what influence they had on the sale price. The above referenced closing costs assistance is the most common seller participation in our area. 9. Arm’s Length Transaction • Before a sale can be relied upon as an • indication of what the subject property is worth, it must be an ARM’S LENGTH TRANSACTION. This means that buyer and seller are both well informed, under no pressure to either buy or sell, and that the property is offered for a reasonable time on the open market. • AND probably are not related to each other!!! TQ III. Cost Approach REQUIRED TO BE ON THE APPRAISAL FORMS USED FOR FNMA, FHLMC, FHA, VA OR ANY OTHER CURRENT TYPE OF LOAN…..NOT USED BY THE UNDERWRITER TO DETERMINE VALUE OR RISK IN 99% OF SITUATIONS!! TQ Cost Approach • The cost approach is based on the presumption that • • buyers will not pay more for an older property than the cost of purchasing a newly constructed residence at the site. Residential appraisers keep abreast of current construction costs in their areas and refer to them when using the cost approach. There are three steps in the cost approach: 1. Estimate the cost of replacing the house with a new home that is similar to the existing one utilizing the information from the cost handbook. 2. Estimate and deduct accrued depreciation from all sources. 3. Add the value of the lot to the depreciated value of the house. (cont.) • The appraiser will then deduct all sources of accrued depreciation from the cost new. • Appraisers also make adjustment on the presumption that a used home is not as valuable as a new home and that it may have suffered a loss in value for one of the following reasons: – – – – PHYSICAL OBSOLESCENCE FUNCTIONAL OBSOLESCENCE ECONOMIC OBSOLESCENCE CURABLE/ NOT CURABLE – TRULY IS PART OF PROCESS TQ IV. Income Approach THIS IS AN IMPORTANT PART (ONLY) OF A “NONOWNER OCCUPIED” OR “INVESTMENT” PROPERTY! TQ Income Approach • The majority of single-family residences are not income producing • • • • • properties (rentals), so traditional income analysis and appraisal techniques do not apply. However, some single-family residences are rented, for which lenders will request an income approach. Generally, this is provided by using a GROSS RENT MULTIPLIER (GRM) which is determined by dividing the sales price of a series of at least three recent sales of similar single family rental properties by their monthly rental income. Example: Sales price $100,000 ÷ $900 monthly rent = 111 gross rent multiplier. The appraiser will then select a multiplier from the range that has been developed. He or she will then multiply that multiplier by the subjects rent to determine the value by the income approach. RENTAL SURVEY/INCOME ANALYSIS • THIS IS AN ADDENDUM WHICH MUST BE ORDERED AND PAID EXTRA (ABOUT $100-150) ON ANY INVESTMENT PROPERTY APPRAISAL TQ V. Understanding the Appraisal Process NEW LAWS APPLY TO THE APPRAISAL PROCESS •ONE IS THE “HVCC” LAW •This law requires lenders to order appraisals thru a 3rd party TQ •The purpose is to avoid any pressure (which was already illegal) by a loan officer or lender on the appraiser to reach a value that the lender wanted “or else”. TQ •The net result, more expensive appraisals; slower appraisals; more re-inspections by appraisers…..all adding extra expense and delay to the process…. TQ Real Estate Settlement Procedures Act TQ • This is the law that the HVCC was added to • It already was illegal to pressure appraisers, but now it’s more expensive too! • A great example of the government “helping” us! Understanding the Appraisal Process • Real estate agents and loan brokers need to • understand the basic steps in the appraisal process because it will help them eliminate, or at least minimize, a prevalent problem that has plagued the industry—both agents and loan brokers tend to overvalue properties. SEE PREVIOUS SLIDES A. HOW TO SOLVE PROBLEMS CAUSED BY LOW APPRAISALS • Of course the best way to eliminate the problems created by low • • • • appraisals is to avoid them in the first place by pricing properties realistically. A seller should not be given an unrealistic estimate of his property’s worth. TQ Regardless of how objective an appraiser may be, there are some subjective considerations and conclusions in every report. TQ An appraisal is an opinion of value. TQ If you are affected by a low appraisal and sincerely believe that the appraiser has made a mistake, you can appeal his or her decision and, with the proper documentation sent to your lender, get the appraisal increased, possibly to the figure originally requested. TQ VI. Key Considerations to a Residential Appraiser • There are many things to consider during the residential appraisal process. • Some of them are very important, others are not. • The following is a summary of property features that are considered important by appraisers. • • • • • • • • • • • • • • • • • • • • • • Location Owner-Occupied Vacancies Rental Levels Construction Activity Conformity Changing Land Use Size and Shape of Lots Contour of the Land Street Patterns Utilities Nuisances Proximity to Services Zoning Site/View Design and Appeal Construction Quality Age/Condition Functional Utility Energy-Efficient Items Room Count Square Footage VII. Rural and Suburban Homes PART OF APPLE VALLEY AND HESPERIA AND VICTORVILLE; PHELAN; PINON HILLS….ALL ARE PARTIALLY AT LEAST THE ABOVE….THE OTHER SELECTION WOULD BE “URBAN” . IT APPEARS THAT PART OF VICTORVILLE COULD BE CALLED URBAN, BUT IT’S A JUDGEMENT CALL REALLY. FYI NOT TQ Rural and Suburban Homes • Properties in outlying areas are eligible for maximum financing by both the primary and secondary market subject to the following conditions. 1. The value of the land is not more than 49% of the overall value of the property. 2. There are adequate public or private utilities in service on the property. 3. The property is accessible by a federal, state, or county highway or an all-weather secondary road. 4. The present or anticipated use of adjacent real estate does not unfavorably affect the value of the property as a residence. VIII. Atypical Property and Loan Types Atypical (NON CONFORMING) Property and Loan Types • ATYPICAL PROPERTIES, which are also • • called non-conforming properties, include, but are not limited to, manufactured homes, dome homes, and log cabins. These must be appraised by a Certified Level Appraiser only. Licensed Level Appraisers are only permitted to appraise conforming properties and loans. Alert IX. CHAPTER SUMMARY • Lenders demand professional appraisals because they want an • • • • entirely objective opinion of the true market values of the properties they loan upon. Loan-to-value ratios are based on the sales price or the appraised value, whichever is lower. All appraisers, and those who use their appraisals for federal loan transactions, must adhere to the Uniform Standards of Professional Appraisal Practice (USPAP) as well as state and federal lending and appraisal regulations. The appraiser is required to follow the appraisal process. For loans, the appraiser is asked to determine the “Market Value” of the property. This is a specifically defined value that may be either higher or lower than the actual selling price of a property. HONEST AND ETHICAL PRACTICES CAN ELIMINATE THE NEED FOR OVERREGULATION BY GOVERNMENT IN MY OPINION…..THINK Chapter Summary (cont.) • Appraisers use the market approach, the cost approach, and the income • • • • approach when valuing properties. The market approach is the most useful for residential properties, as it reflects what actually is occurring in the marketplace. Comparables used in this approach should be recent sales in the same general neighborhood or area as the subject and as similar to the subject as possible. They must be real closed sales at “arm’s length.” The cost approach is carried out with the use of cost handbooks. Appraisers estimate the overall accrued depreciation of a property by taking into account any physical, functional, or economic obsolescence that it may have incurred. The income approach is seldom used unless the property is a rental. Then a Gross Rent Multiplier is used to determine value. It is useful for agents, brokers, and others to understand the appraisal process in order to keep from overvaluing properties and losing sales as a result. TQ