Transcript RF PP Lesson 07 Revised

Financing Residential Real Estate
Lesson 7:
The Financing Process
Introduction
In this lesson we will cover the stages of the
financing process, including:
1. shopping for a loan,
2. applying for a loan,
3. application processing, and
4. closing.
Shopping for a Loan
For home buyers, shopping for a mortgage loan
involves:
assessing wants, needs, and finances;
choosing a lender;
comparing rates and fees; and
evaluating financing options.
Shopping for a Loan
Assessing the buyers’ circumstances
Buyers should get a realistic idea of what they can
afford before they start house hunting.
To establish a price range, they need to find
out how much financing they can qualify for.
Shopping for a Loan
Assessing the buyers’ circumstances
Buyers should get a realistic idea of what they can
afford before they start house hunting.
To establish a price range, they need to find
out how much financing they can qualify for.
Two ways of doing that:
 Prequalifying
 Preapproval
Assessing Buyers’ Circumstances
Prequalifying vs. preapproval
Prequalifying
Informal process that can be done by real estate
agent or using online mortgage calculator
Assessing Buyers’ Circumstances
Prequalifying vs. preapproval
Prequalifying
Informal process that can be done by real estate
agent or using online mortgage calculator
Rough estimate of maximum loan amount
Assessing Buyers’ Circumstances
Prequalifying vs. preapproval
Prequalifying
Informal process that can be done by real estate
agent or using online mortgage calculator
Rough estimate of maximum loan amount
Preapproval
Formal process that can be done only by lender
(through loan officer or mortgage broker)
Assessing Buyers’ Circumstances
Prequalifying vs. preapproval
Prequalifying
Informal process that can be done by real estate
agent or using online mortgage calculator
Rough estimate of maximum loan amount
Preapproval
Formal process that can be done only by lender
(through loan officer or mortgage broker)
Specific maximum loan amount
Assessing Buyers’ Circumstances
Prequalifying vs. preapproval
For preapproval, buyers must:
complete a loan application, and
provide documentation of income, assets,
debts, and credit history.
Assessing Buyers’ Circumstances
Prequalifying vs. preapproval
For preapproval, buyers must:
complete a loan application, and
provide documentation of income, assets,
debts, and credit history.
Lender gives buyers a preapproval letter, agreeing
to loan up to a specified amount.
Assessing Buyers’ Circumstances
Prequalifying vs. preapproval
Advantages of preapproval:
Tool in negotiations with sellers
Streamlines closing process
Preapproval now widely used.
In active market, seller might not even consider
offers from buyers who aren’t preapproved.
Assessing Buyers’ Circumstances
Prequalifying vs. preapproval
Before preapproval became common, prequalifying
was standard practice of real estate agents.
Prequalifying is still useful for buyers who aren’t
ready to apply for preapproval.
May want to get idea of what’s available
and what they can afford.
Knowing how to prequalify a buyer can also
help agent understand underwriting process.
Assessing Buyers’ Circumstances
How to prequalify buyers
Basic steps in prequalifying:
1. Apply income ratios to monthly income to find
maximum monthly payment.
 Must cover principal, interest, taxes, and
insurance (PITI).
Assessing Buyers’ Circumstances
How to prequalify buyers
Basic steps in prequalifying:
1. Apply income ratios to monthly income to find
maximum monthly payment.
 Must cover principal, interest, taxes, and
insurance (PITI).
2. Subtract percentage (representing property
taxes and insurance) from PITI figure to find
maximum principal and interest payment.
Assessing Buyers’ Circumstances
How to prequalify buyers
3. Use current market interest rate to calculate
maximum loan amount based on maximum
principal and interest payment.
Assessing Buyers’ Circumstances
How to prequalify buyers
3. Use current market interest rate to calculate
maximum loan amount based on maximum
principal and interest payment.
4. Divide maximum loan amount by LTV ratio to
determine ceiling of price range.
Assessing Buyers’ Circumstances
Getting preapproved
While prequalifying can be useful, buyers should
be encouraged to get preapproved as soon as
possible.
Apply to lender or to mortgage broker.
Assessing Buyers’ Circumstances
Getting preapproved
While prequalifying can be useful, buyers should
be encouraged to get preapproved as soon as
possible.
Apply to lender or to mortgage broker.
Ask mortgage broker to obtain preapproval
letter issued directly by lender.
Preapproval letter issued by mortgage
broker doesn’t actually commit lender.
Assessing Buyers’ Circumstances
Getting preapproved
Preapproval letter valid only for limited period (such
as 30 days).
To get preapproval extended, buyers’
information will have to be verified again.
Summary
Preapproval and Choosing a Lender
Prequalifying
Preapproval
Preapproval letter
PITI
Loan originator
Loan officer
Mortgage broker
Referral
Good faith estimate of costs
Loan Costs
Primary consideration for most buyers in choosing
lender is how much loan will cost.
Loan Costs
Primary consideration for most buyers in choosing
lender is how much loan will cost.
In addition to interest rate, cost of loan may include:
 loan origination fee,
 discount points,
 miscellaneous charges, and
 mortgage broker’s fee.
Loan Costs
Points
Point = percentage point
1 point = 1% of loan amount
Loan Costs
Points
Point = percentage point
1 point = 1% of loan amount
Usage issue:
 Some lenders use “points” to refer to
origination fee and discount points
together.
 Others use “points” to refer only to
discount points.
Loan Costs
Loan origination fee
Origination fee pays for lender’s expenses, such as
staff compensation, facilities costs, and other
overhead.
Charged in almost every mortgage
transaction.
Typically around 1% of loan amount.
Paid at closing, usually by borrower.
Loan Costs
Discount points
Discount points are a lump sum paid at closing to
increase lender’s upfront yield (profit) on loan.
In exchange for upfront payment, lender
charges borrower lower interest rate.
May save borrower money in long run,
depending on how long she owns home.
Loan Costs
Discount points
How many discount points lenders charge varies
depending on market conditions and other factors.
 Might charge 4 to 6 points for
1% interest rate reduction.
Loan Costs
Discount points
Example:
Market rate for mortgage: 5.25%
Lender charges 4 points for 1% rate reduction
$300,000 Loan amount
x
4% 4 points
$12,000 Cost of discount
If lender is paid $12,000 up front, will charge
borrower only 4.25% interest on loan.
Loan Costs
Discount points
Discount points may be paid by buyer or seller.
Buydown = Paying lender discount
points to “buy down” buyer’s interest rate.
Loan Costs
Discount points
Discount points may be paid by buyer or seller.
Buydown = Paying lender discount
points to “buy down” buyer’s interest rate.
When buyer pays points, pays lender in cash
at closing.
When seller pays points, amount is withheld
from loan amount and deducted from
seller’s proceeds at closing.
Loan Costs
Miscellaneous fees
In addition to an origination fee and discount points,
lenders often charge borrowers other fees, such as:
 application fee
 document preparation fee
 underwriting fee
Loan Costs
Miscellaneous fees
In addition to an origination fee and discount points,
lenders often charge borrowers other fees, such as:
 application fee
 document preparation fee
 underwriting fee
These vary widely from one lender to another.
Borrower should ask loan originator if
any can be reduced or waived.
Loan Costs
Mortgage broker’s compensation
Buyers working with mortgage broker are generally
charged a mortgage broker’s fee.
May be separate fee or included in points
quote for loan.
Loan Costs
Mortgage broker’s compensation
Buyers working with mortgage broker are generally
charged a mortgage broker’s fee.
May be separate fee or included in points
quote for loan.
Shouldn’t make loan more expensive than
one obtained without a broker’s help.
Broker gets loan at wholesale price, marks
it up to retail price, keeps overage
as fee.
Loan Costs
Mortgage broker’s compensation
Controversy over another form of mortgage broker
compensation: yield spread premium (YSP).
Loan Costs
Mortgage broker’s compensation
Controversy over another form of mortgage broker
compensation: yield spread premium (YSP).
Broker persuades borrower to accept a loan at
“above par” (higher-than-market) interest rate.
Loan Costs
Mortgage broker’s compensation
Controversy over another form of mortgage broker
compensation: yield spread premium (YSP).
Broker persuades borrower to accept a loan at
“above par” (higher-than-market) interest rate.
Lender pays broker YSP based on difference
between market rate and borrower’s rate.
Loan Costs
Mortgage broker’s compensation
Controversy over another form of mortgage broker
compensation: yield spread premium (YSP).
Broker persuades borrower to accept a loan at
“above par” (higher-than-market) interest rate.
Lender pays broker YSP based on difference
between market rate and borrower’s rate.
Practice gives mortgage brokers incentive to
steer borrowers to more expensive
loans.
Comparing the Cost of Loans
Truth in Lending Act
The various fees charged in addition to interest
make it hard to compare loans offered by different
lenders.
Truth in Lending Act (TILA): federal consumer
protection law that requires lenders to disclose the
cost of a loan using certain figures and terminology,
to make comparison easier.
Truth in Lending Act
Annual percentage rate
Most important TILA disclosure: annual percentage
rate (APR).
APR expresses relationship between all of the
financing charges and the amount borrowed as
a percentage.
To determine which of two loans is more
expensive, compare APRs, not just interest
rates.
Truth in Lending Act
Total finance charge
Another key TILA disclosure: total finance charge.
Total finance charge includes:
 interest,
 origination fee,
 discount points paid by borrower,
 mortgage broker’s fee,
 finder’s fee,
 service fee, and/or
 mortgage guaranty or
insurance fees.
Truth in Lending Act
Total finance charge
Total finance charge does NOT include:
 title insurance costs,
 credit report charges,
 appraisal fee, or
 discount points paid by seller.
Loan Costs
No-fee or low-fee loans
Some lenders offer no-fee loans or low-fee loans.
No major lender charges such as origination fee
or discount points.
Only (or almost only) financing charge is
interest.
Interest rate often much higher than rate for
loan with standard fees.
Helpful for buyers with little cash for
closing.
Summary
Loan Costs and Financing Options
Origination fee
Discount points
Buydown
Mortgage broker’s fee
Truth in Lending Act
APR
Total finance charge
No-fee or low-fee loan
Home buyer counseling
Applying for a Loan
Loan interview
After buyers have chosen a lender, next step is to
apply for a loan (or for preapproval).
Loan interview: buyers talk with loan originator
in person, on phone, by fax, or online
Applying for a Loan
Loan interview
After buyers have chosen a lender, next step is to
apply for a loan (or for preapproval).
Loan interview: buyers talk with loan originator
in person, on phone, by fax, or online
Originator helps buyers:
choose best financing option
prepare application
Loan Interview
Prequalifying during interview
During loan interview, originator may enter
information into automated underwriting system.
System provides preliminary evaluation of what
buyers are likely to qualify for.
This does not guarantee preapproval.
Loan Interview
Deposit
Loan originator may require buyers to make a
deposit to cover certain expenses.
May include:
 application fee,
 credit report fee, and
 other preliminary charges.
Loan Interview
Contract and closing date
If buyers have already signed purchase agreement,
loan originator reviews contract.
Main concerns:
 terms of financing contingency
 closing date
Applying for a Loan
Loan application form
Mortgage lenders almost always use Uniform
Residential Loan Application form.
Loan Application Form
Types and terms of loan
First section of form asks about:
 type of loan
 loan amount
 loan term
 interest rate
 whether rate is fixed or adjustable
 any special amortization
arrangement
Loan Application Form
Property information and purpose
Second section asks about property:
 address
 legal description
 when house was built
Loan Application Form
Property information and purpose
Second section asks about property:
 address
 legal description
 when house was built
Also asks about purpose of loan:
 purchase, construction, refinancing
 primary residence, secondary
residence, investment property
Loan Application Form
Property information and purpose
Second section also asks about:
 how buyers will take title
 source of downpayment and other
funds for closing
 secondary financing
Loan Application Form
Borrower/co-borrower information
Third section asks for this info about each applicant:
 name
 social security number
 phone number
 date of birth
 years of schooling
 marital status
 number and age of any dependents
 address or addresses during
past two years
Loan Application Form
Borrower/co-borrower information
Legal for lender to ask about marital status
and dependents.
Illegal for lender to use this information
in a discriminatory way.
Loan Application Form
Employment information
Each applicant must also provide:
 name and address of employer
 number of years employed at this job
 number of years in this line of work
 position held and title
 type of business
 business phone number
Loan Application Form
Income and monthly housing expense
This section asks about:
 primary employment income
 overtime, bonuses, or commissions
 dividends and interest
 net rental income
 other sources of income
 current rent or mortgage
payment
Loan Application Form
Assets and liabilities
Assets may include:
 good faith deposit
 money in bank
 investments
 life insurance policy
 retirement account
 automobile
 personal property
 real property
Loan Application Form
Assets and liabilities
Liabilities may include:
 student loan
 car loan
 real estate loan
 other installment loan
 charge accounts
 credit cards
 alimony/child support
 job-related expenses
Loan Application Form
Details of transaction
Application also asks for information about
transaction, including:
 purchase price
 cost of alterations/improvements
 cost of land
 prepaid expenses
 closing costs
Loan Application Form
Declarations
Applicants must answer questions about:
 outstanding judgments
 bankruptcies
 foreclosures or deeds in lieu
 lawsuits
 alimony/child support
 citizenship
Loan Application Form
Declarations
Applicants also must state:
 whether any portion of downpayment
was borrowed
 whether property is to be primary
residence
 whether they have owned any other
property in last three years
Loan Application Form
Acknowledgement and agreement
Applicants agree to several provisions regarding
application and loan by signing and dating form.
For example, they agree to correct or update
information on application if necessary.
Loan Application Form
Information for government monitoring
Form also has optional questions regarding
applicants’ ethnicity, race, and sex.
Used by federal government to assess lender’s
compliance with fair lending laws.
Loan Application Form
Continuation sheet
Last page of application form is for applicants to use
if they need more room to answer any of form’s
questions.
Loan Application Form
Application checklist
Real estate agent should let buyers know what
information they need to collect for loan application.
Applying for a Loan
Federal disclosure requirements
Two federal laws require lenders to disclose
information to loan applicants:
Applying for a Loan
Federal disclosure requirements
Two federal laws require lenders to disclose
information to loan applicants:
Truth in Lending Act (TILA)
APR, total finance charge, lender’s charges
Applying for a Loan
Federal disclosure requirements
Two federal laws require lenders to disclose
information to loan applicants:
Truth in Lending Act (TILA)
APR, total finance charge, lender’s charges
Real Estate Settlement Procedures Act (RESPA)
Good faith estimate of closing costs
Booklet about closing process
Mortgage servicing disclosure
Applying for a Loan
Federal disclosure requirements
Lenders must provide all of these within three
business days after loan application is submitted.
Disclosures not required if application
rejected before three-day deadline.
If any costs change, new disclosures
must be made before closing.
Applying for a Loan
Locking in the interest rate
Buyers should ask loan originator about locking in
the interest rate.
Lock-in = lender guarantees certain
interest rate for specified period.
Float = interest rate will move up or down
with market interest rates until closing.
Applying for a Loan
Locking in the interest rate
If interest rate not locked in, sharp increase in rates
might increase monthly payment so much that
buyers no longer qualify.
Applying for a Loan
Locking in the interest rate
If interest rate not locked in, sharp increase in rates
might increase monthly payment so much that
buyers no longer qualify.
Terms of lock-in agreement should be in writing.
Locking in the Interest Rate
Lock-in period
Lock-in agreement should state how long the rate
will be locked in.
Lock-in period should extend beyond expected
loan processing time.
Some lenders provide free automatic extension
if closing delayed.
Locking in the Interest Rate
Lock-in fee
Lender may charge fee to lock in rate.
If loan approved, fee usually applied to
closing costs.
If application rejected, fee usually refunded.
Locking in the Interest Rate
Rate decreases
If market interest rates are more likely to go down
than up, doesn’t make sense to lock rate.
Lender can usually charge locked-in rate
even if market rates have gone down.
Summary
Applying for a Loan
Uniform Residential Loan Application form
Real Estate Settlement Procedures Act
Good faith estimate of closing costs
Rate lock-in
Float
Application Processing
After application form filled out:
verification forms sent to applicants’ employers
and banks;
credit reports and credit scores obtained; and
if buyers have entered into a purchase
agreement:
appraisal ordered
title report ordered
Application Processing
After verification forms returned and reports
received, loan processor puts together loan
package and sends it to underwriting department.
The Underwriting Decision
Underwriter carefully reviews loan package and
applies appropriate qualifying standards to buyers.
May use automated underwriting system
to perform these steps.
The Underwriting Decision
Underwriter carefully reviews loan package and
applies appropriate qualifying standards to buyers.
May use automated underwriting system
to perform these steps.
Loan is:
 approved,
 rejected, or
 approved subject to conditions.
The Underwriting Decision
Rejection
If loan denied, lender must provide explanation.
Written statement within 30 days.
The Underwriting Decision
Rejection
If loan denied, lender must provide explanation.
Written statement within 30 days.
Buyers may want to:
apply to different lender
apply for different type of loan
wait and take steps to improve finances
The Underwriting Decision
Conditional commitment
Conditional commitment commits lender to making
loan if buyers:
fulfill specified conditions, and/or
submit additional documentation.
The Underwriting Decision
Preapproval letter
Preapproval is a form of conditional commitment.
Approval contingent on:
satisfactory appraisal
satisfactory title report
The Underwriting Decision
Preapproval letter
Preapproval letter states that lender will loan buyers
up to a specified amount to buy a house.
Expires at end of specified period.
Lender may agree to extension if buyers’
information reverified.
The Underwriting Decision
Final commitment
When all conditions for approval are satisfied,
lender issues final commitment letter.
 Confirms loan terms.
 Has expiration date.
Closing the Loan
Escrow
Last stage of financing process coordinated with
closing of property sale.
In many areas, closings are handled through
escrow.
Escrow: neutral third party holds money and
documents for buyer and seller until transaction
ready to close.
Closing the Loan
Closing agent
Closing agent (escrow agent):
makes sure all requirements are taken care of
before closing date, and
disburses purchase price and delivers deed
when conditions in purchase agreement are
satisfied.
Closing the Loan
Closing agent
Closing agent may be:
 independent escrow agent
 employee of lender
 title company
 lawyer
 real estate broker
Closing the Loan
Steps in closing process
 Clearing and insuring title
 Inspections and repairs
 Loan documents issued and signed
 Funding the loan
 Preparing settlement statements
 Recording documents
 Disbursing funds
Steps in Closing Process
Clearing and insuring title
Any liens that would have higher priority than new
mortgage or deed of trust must be removed.
Doesn’t include property tax or special
assessment liens.
Steps in Closing Process
Clearing and insuring title
Any liens that would have higher priority than new
mortgage or deed of trust must be removed.
Doesn’t include property tax or special
assessment liens.
To remove lien:
seller pays amount owed
release obtained and recorded
Steps in Closing Process
Clearing and insuring title
Lender will require extended coverage title
insurance policy to protect lien priority.
Usually paid for by buyer.
Steps in Closing Process
Inspections and repairs
Lender may require inspections or tests, such as:
 pest control inspection
 soil percolation test
 flood hazard inspection
Steps in Closing Process
Inspections and repairs
Lender may require inspections or tests, such as:
 pest control inspection
 soil percolation test
 flood hazard inspection
Based on inspection report, lender decides
whether to require repairs or other corrective
steps.
May or may not have to be
completed by closing date.
Steps in Closing Process
Loan documents and buyer’s funds
Once loan has been approved, lender forwards loan
documents to closing agent.
Buyer:
deposits funds required for closing (such as
downpayment, closing costs) into escrow, and
signs loan documents.
Steps in Closing Process
Impound account
Lender often requires buyer to make a deposit into
an impound account at closing.
Steps in Closing Process
Impound account
Lender often requires buyer to make a deposit into
an impound account at closing.
Impound account ensures taxes and insurance
will be paid on time.
Portion of buyer’s monthly payment goes
into impound account.
Lender pays taxes and insurance out of
account when due.
Steps in Closing Process
Impound account
Lender often requires buyer to make a deposit into
an impound account at closing.
Impound account ensures taxes and insurance
will be paid on time.
Portion of buyer’s monthly payment goes
into impound account.
Lender pays taxes and insurance out of
account when due.
Illegal to require deposit of more than
two months of impounds at closing.
Steps in Closing Process
Interim interest
Buyer will also pay interim interest (prepaid interest)
at closing.
Steps in Closing Process
Interim interest
Buyer will also pay interim interest (prepaid interest)
at closing.
Interim interest necessary because:
1. Buyer’s first payment is not due on first day of
month immediately after closing.
Instead, due first day of month after that.
Steps in Closing Process
Interim interest
Buyer will also pay interim interest (prepaid interest)
at closing.
Interim interest necessary because:
1. Buyer’s first payment is not due on first day of
month immediately after closing.
Instead, due first day of month after that.
2. Mortgage interest paid in arrears, after it accrues.
Monthly payment includes the
interest that accrued during
previous month.
Steps in Closing Process
Interim interest
Example: Closing date is January 23.
First mortgage payment will be due March 1.
No mortgage payment due February 1.
Steps in Closing Process
Interim interest
Example: Closing date is January 23.
First mortgage payment will be due March 1.
No mortgage payment due February 1.
But interest begins accruing on closing date.
Steps in Closing Process
Interim interest
Example: Closing date is January 23.
First mortgage payment will be due March 1.
No mortgage payment due February 1.
But interest begins accruing on closing date.
March 1 payment will cover interest that
accrues during February.
Steps in Closing Process
Interim interest
Example: Closing date is January 23.
First mortgage payment will be due March 1.
No mortgage payment due February 1.
But interest begins accruing on closing date.
March 1 payment will cover interest that
accrues during February.
But won’t cover interest accruing from
January 23 to January 31.
Steps in Closing Process
Interim interest
Example: Closing date is January 23.
First mortgage payment will be due March 1.
No mortgage payment due February 1.
But interest begins accruing on closing date.
March 1 payment will cover interest that
accrues during February.
But won’t cover interest accruing from
January 23 to January 31.
Interim interest payment at closing
covers those 9 days.
Steps in Closing Process
Funding the loan
Funding the loan: When lender releases buyer’s
loan funds to closing agent.
Loan funded only after:
buyer signs loan documents,
lender reverifies buyer’s employment and
other information, and
any other conditions imposed by lender
have been satisfied.
Steps in Closing Process
Settlement statements
Closing agent prepares final settlement statements
for buyer and seller.
Itemizes charges and credits for each party.
Steps in Closing Process
Settlement statements
Closing agent prepares final settlement statements
for buyer and seller.
Itemizes charges and credits for each party.
To comply with RESPA, closing agent must:
use Uniform Settlement Statement
form, and
allow buyer to review statement at least
one day before closing, if buyer
asks to.
Steps in Closing Process
Final steps
Closing agent:
records deed, mortgage or deed of trust,
lien releases, and other documents;
disburses funds to appropriate parties.
Title company issues policies.
Lender gives buyer copy of loan documents in
final form.
Buyer gives lender copy of hazard insurance
policy.
Summary
Application Processing and Closing
Loan package
Rejection
Conditional commitment
Preapproval letter
Final commitment
Closing agent
Escrow
Interim interest
Impound account
Funding the loan