How To Get A Mortgage Loan

Purchasing or refinancing a home or investment property is easier than you think. It is a well-defined, highly detailed process that routinely takes two or three weeks to complete.

This article will provide an outline of the process and details of obtaining a mortgage as well as the basic residential loan products.

The steps in obtaining a mortgage loan are as follows:

1) Make an application either in person with a loan broker or over the Internet.

2) Sign a completed application and other disclosures including a Good Faith Estimate, which is an estimate of your closing costs and monthly payment. If purchasing a property, then submit the purchase contract.

3) Obtain loan approval after income disclosure and a credit check.

4) Provide required income, asset, and other documentation.

5) Obtain an appraisal and select a title company to close.

6) Go to the title company to sign the loan documents.

This entire process only takes a few hours of time.

Remember one very important part of the Conventional loan process: Humans do not approve loans; computers approve loans. With a very few exceptions, people do not make the fundamental underwriting decision. Your loan will be input into an automated system and either approved or denied by a computer program.

The computer program, often called DU/DO, will assess the overall credit risk of the applicants and make a decision based upon the perceived risk of the loan request. The three major risk factors taken into account as the loan is analyzed are: the applicant’s income ratios, credit history, and equity position in the property being financed.

III. THE APPLICATION PROCESS

The standard application is called a Fannie Mae Form 1003. It is a three-page form plus a continuation page. The 1003 requires basic information about the loan amount, term, and interest rate. It also asks about the applicant’s residence, income, assets, liabilities, and work history. This form can be very frustrating for someone who has never filled one out. It can easily take 40 minutes or longer. Experienced mortgage brokers will often interview the applicants and complete the 1003 for them.

The loan broker inputs the application into the DU/DO system. After input, the computer obtains the borrowers credit report and internally scores the application. This process of pulling credit, scoring the loan, and approving it rarely takes over 90 seconds. The approval is transmitted to the broker, and it stipulates certain conditions to be met and income documentation to be provided.

Approvals stipulate varying sets of conditions because the DU/DO approval is risk scored and scores are rarely the same. In most cases, the less risk perceived by DU/DO, the fewer stipulations and documentation required. On the other hand, the higher the perceived risk, the more documentation that is required.

The applicants should be prepared to provide most, but not necessarily all, of the following documentation:

1. W-2's for the most recent 2 years. If self-employed, two years of Federal (not State) tax returns.

2. One complete month of the most recent pay stubs.

3. Two months of the most recent bank statements. (Bank statements and pay stubs should be dated within 30 days of loan closing.)

4. Homeowners Insurance agent’s name and phone number.

IV. QUALIFYING RATIOS

Lenders want to feel confident that borrowers can meet the monthly repayment of principal, interest, taxes, and insurance on their loans. To insure the borrowers have enough income, qualifying ratios are computed. There are two ratios computed on each application and they are simply called the front and the back ratios.

The front ratio is computed as follows:

Borrower's estimated monthly loan payment divided by the borrower's monthly income. The loan payment includes principal, interest, taxes, insurance and, if any, the mortgage insurance and homeowners association fees.

The back ratio is the monthly loan payment plus all other installment and credit card payments divided by the borrower's monthly income. In addition to installment and credit card payments, also included are alimony and child support payments, as well as student loans.

An example will best serve as clarification. Borrower's monthly income is $5,000. The proposed total monthly loan payment is $1,500. The borrowers have monthly installment and credit card payments of $500.

Front Ratio $1500 / $5000 = 30%

Back Ratio $1500+$500 / $5000 = 40%

DU/DO does not have fixed ratio maximums. Several years ago, before DU/DO, the guidelines for the front and back ratios were 36% and 43%, respectively. Now with risk based underwriting, the DU/DO program will expand the ratios significantly when other risk factors are negligible. DU/DO has approved borrowers to the mid 50% back ratios when they had excellent credit scores and equity positions of 25% or more.

DU/DO is more critical of the back ratio than the front ratio.

V. CREDIT REPORTS

A very important aspect to obtaining a loan with a favorable interest rate is the applicant’s credit history. Credit history is an important, if not the most important, of the three major risk factors.

There are three credit repositories in the United States. They are: Experian, TransUnion, and Equifax. Each of these companies computes its own unique credit score. The scoring systems are respectively called Fair Isaac Credit Organization (most commonly called FICO), Empirica, and Beacon respectively. These scoring systems are slightly different, and the scores can be as low as 350 or as high as 900.

The FICO scores are based upon statistical models that are proven to have a high correlation in determining or predicting future credit performance. It has been statistically proven that the lower a score, the more likely a borrower will have delinquency problems. Likewise, it has been shown that the higher a score, the greater the probability for repayment.

The DU/DO programs are based upon the borrower’s middle (of three) credit score. Generally, the DU/DO programs set the minimum score for a conventional loan to be 620. There are exceptions to this 620 score but since the programming of both the DU/DO and the FICO systems is proprietary, it is not possible to further define the exceptions.

General guidelines for interpreting FICO scores among conventional and portfolio lenders are as follows:

Scores Below 620 Subprime (or B, C, &D)

620 to 679 Average Score

680 to 719 Good Score

Credit reports frequently contain errors and the scores can easily show spreads of 50 to 100 points between the high and low scores. The most common types of errors are duplicate accounts, open loans that have been paid, open collection items that have been paid, and judgments or charge offs that have been paid. There are procedures for correcting and updating individual scores and these methods will be discussed in a separate article.

Credit reports can cost from between $20 to $45. The cost is dependent on the number of repositories pulled and, if necessary, the amounts of extra work that is performed by a third party credit reporting agency to remove inaccurate items.

It must be noted that loans insured by the Federal Housing Administration (FHA) are not underwritten based upon credit scores. That is not to be misinterpreted; the FHA loans strongly consider the applicants credit history, not their credit score. This feature of FHA loans will be more fully discussed in a later chapter.

There are four types of general residential appraisals. They range from a simple drive-by inspection with no value assigned to a full Uniform Residential Appraisal Report (URAR). The DU/DO program specifies the type of appraisal based upon its internally assigned risk assessment. For example, a purchase with 30% down payment and borrowers with excellent credit will likely require a drive-by inspection. But a cash-out refinance on a highly leveraged property to a person with an average credit score will likely require a full appraisal, if it is approved at all.

The three types of appraisals and their approximate costs are:

1) A drive-by inspection that is not an appraisal. This type generally costs $200 to $250.

2) A drive by appraisal where the appraiser provides comparable values for other properties in the neighborhood. This appraisal generally costs 200 to $250.

3) A Form 2055 that is much more detailed than the first two. This appraisal can be an exterior only appraisal or the DU/DO program can request an interior inspection. This appraisal generally costs $300 to $350.

A word of caution is appropriate. Do not order your own appraisal. There are several reasons for this. The lender may have its own list of approved appraisers or you may order from an appraiser who is not properly licensed. Furthermore, the lenders name, as well as the borrower's name, must be provided in the body of the appraisal report.

The equity in a property being purchase or refinanced is important. The equity is the difference between the purchase price or the appraised value and the loan amount. With a purchase, the purchase price is always used for determining equity. The manner for describing equity is “loan to value.” The easiest way to define the loan to value (LTV) is to compute it. Suppose the purchase price or appraised value is $100,000 and the loan amount is $80,000. The LTV is 80% and the borrower has a $20,000 or 20% equity in the property.

VII. MORTGAGE INSURANCE

Mortgage insurance (MI) or private mortgage insurance (PMI) is not the same as homeowners insurance. Mortgage Insurance insures the lender in the event the borrower defaults and the lender is forced to foreclose and sell the property.

Mortgage insurance is required on any conventional loan where the loan to value exceeds 80%. FHA loans require PMI regardless of the loan to value and the amount is a fixed .5% in all cases. For conventional loans, the higher the loan to value, the higher the MI premium. There are many MI companies and they have slightly different rate schedules. Rates from one of the MI companies for standard coverage’s are as follows:

LTV 80.01 to 85% .32% of the

DU/DO will compile the risk profile of the loan and may require additional mortgage insurance coverage to adequately cover the associated risks. Higher coverage requirements by DU/DO translate to a higher mortgage insurance premium.

To calculate the monthly premium on a $100,000 loan at an 85.01% to 90% LTV, first multiply $100,000 times .52%. That amount is $520 and it is the annual MI premium. To arrive at the monthly premium divided $520 by 12 months. $43.33 is the monthly premium. MI premiums are included in your monthly payment with principal, interest, taxes, and insurance. (PITIMI)

VIII. BASIC LOAN PRODUCTS

a. Conventional Loans

Conventional Loans are the cornerstone of the mortgage industry. Most of the preceding text has been based on an explanation of conventional loans. DU/DO is the underwriting system for conventional loans. Conventional loans specify high standards and require good credit scores. They generally provide the lowest rates available and they represent the bulk of the loans that are originated in the United States. Disadvantages of conventional loans are that they are heavily weighted to credit scores and limited to some extent by qualifying ratios. Solid loans to low risk borrowers are sometimes denied by DU/DO.

b. Federal Housing Administration - FHA Loans

FHA loans are the second most popular loans. They are frequently used for first time home buyers and for other purchasers who have good credit but for some reason have lower credit scores. The automated systems for FHA loans are call Loan Prospector (LP) and Desktop Underwriting (DU)and they do not underwrite based upon FICO scores. This aspect of FHA loans is very significant. That is, many prospective borrowers have old/aged derogatory information on their credit bureau reports. Collection Agency items and Judgments, even though paid, still have very negative effects on credit scores.

The DU or LP system will analyze the credit reports and if the derogatory items are sufficiently aged, will approve the borrower. DU/DO on the other hand, will deny the borrower based upon the score alone and not an analysis of the borrower's situation.

FHA loans can also be underwritten by a human. FHA gives the option to select lenders to manually underwrite loans where the circumstances dictate. The underwriter, however, is not allowed to approve an FHA loan that has been denied by the LP system.

Experienced brokers are able to preview an FHA application and determine if the automated system or a human underwriter should approve the loan.

FHA loans, regardless of the Loan to Value, require private mortgage insurance. (PMI) For FHA loans, PMI is required in two forms. The first form is called the one-time, up-front PMI and it is 1.5% of the base loan amount. It is added to the amount financed. The second form is the annual PMI and it is .5% of the base amount and is paid monthly. Because of the two forms of PMI, FHA loans are generally slightly more expensive than conventional loans. FHA loans are very popular and if used properly, can save the borrowers thousands of dollars and allow them to own a home that they might not be able to otherwise afford.

FHA places a maximum loan amount that can be borrowed. This limit is determined on a countywide basis. Mortgage brokers who are authorized to submit FHA loans will have a listing of FHA Mortgage limits. Not all brokers can submit FHA loans, so the borrower must first make sure the broker can submit an FHA loan. Borrowers can obtain their own information about loan limits on the internet at https://entp.hud.gov/idapp/html/hicoslook.cfm

FHA loans can be used in conjunction with down payment assistance programs offered by some cities and counties. In order to use these funds, the borrowers must not exceed HUD median income (family) limits. These limits can be found at http://www.huduser.org/datasets/il/il07/

c. Veterans Affairs - VA Loans

VA loans are for borrowers who have served in the armed forces of the United States. They represent low cost mortgages for current and previous servicemen and women. VA allows the borrowers to finance 100% of the purchase price of a new home. VA enforces high loan standards and will not approve borrowers who have much derogatory credit. VA loans have a one-time, up-front fee of 2% of the loan amount. This fee is called a funding fee, and it is 3% if a Veteran uses their benefits a second time. The funding fee is added to the loan amount. VA loans are generally used for first time home buyers or buyers who have no cash equity to contribute toward the purchase of a home. Once a homeowner has sufficient equity in a home, VA loans are not financially attractive.

More information can be obtained by going directly to VA's web site at http://www.homeloans.va.gov

The first step in obtaining a VA loan is to obtain a "Certificate of Eligibility" The veteran can complete the certificate which is VA Form 26-1880 and deliver it to a VA Eligibility Center. A far easier method is to use an established mortgage broker who can go directly to the VA via the internet and obtain the Certificate of Eligibility online. The veteran can obtain more information on VA loans by internet at www.va.gov. The prompts are self explanatory and clear.

The newest product on the market is the Option ARM. This program has lost popularity because of widespread misuse. It is no longer recommended. This program allows borrowers to select one of four payment programs to use in repaying the loan. They are:

     1. Minimum amount due. (may result in deferred interest - aka negative amortization)
     2. Interest only.
     3. Principal and interest over 30 year amortization.
     4. Principal and interest over 15 year amortization.

The minimum amount due is the most novel of the payment plans. It allows for the first years payment to be calculated at the initial interest rate. (which is generally below market) However, the interest rate on the loan fluctuates monthly (or quarterly) which generally results in part of the interest being deferred. It is deferred by adding the unpaid interest to the unpaid principal balance. This is also called negative amortization and results in the borrower losing equity in their home. The second year of this payment plan allows for the payment to increase a maximum of 7.5% and likewise for the third year. The borrower always has the option of paying more than the minimum amount due or the interest only amount due. When the loan balance (with the deferred interest added to the principal) reaches 110% of the original loan amount, the loan payments are immediately adjusted to fully amortize the loan.

The maximum loan-to-value for this program is 90%. It is available up to a loan amount of $1,500,000.

The loan is priced at a margin (1.75% to 3.35%) over a basic index. The two indexes that are used are the 12-MTA (12 month moving average of 1 year treasury bills) and the COFI (Cost of Funds Index) which is the cost of funds for all savings and loan banks. The loan may have a pre-payment penalty.

This loan is available also as a stated income product. (maximum LTV is 75%)

e. Interest Only Loans

This newer type loan provides for a payment schedule in the first 3 to 5 years of a loan to be interest only payments. That is, there is no principal reduction specified for a certain period of time. At the end of the time period, the borrower begins to make principal and interest payments over the remaining loan term. If the interest only period of the loan was 5 years, then with the 61st payment, the borrower would make principal and interest payments for the remaining 25 year term.
At any time, the borrower may choose to make additional payments to principal. This loan is sometimes referred to as a Interest First loan. This loan is sometimes referred to as a Interest First loan. The automated underwriting systems consider the interest only loan to be slightly higher risk and most investors charge a 1/8% higher interest rate than the corresponding amortizing loan. Also, the maximum loan-to-value for this conventional product is 90%.

f. Stated Income - No Ratio / No Asset Loans

Stated Income and No ratio/no asset loans (both are also called low doc loans) are unique products designed for specific situations. These loans were created for self employed borrowers who were very credit-worthy but who did not possess the necessary income documentation to qualify for a loan. Income documentation was lacking because the applicant's Federal Income Tax Return did not demonstrate sufficient income for debt repayment. Good borrowers were being denied credit by conventional loan programs. This program has lost popularity because of widespread misuse. It is no longer recommended and only narrowly available. Under certain conditions, DU/DO will approve borrowers for stated income documentation but generally the investor will require an IRS form 4506T which allows the investor to verify the borrowers income with the IRS.

With stated income loans, the borrower "states" his income on page 2 of the loan application and the lender does not verify the amount or source of income. Instead, the lender relies on the borrowers high credit score and also on the equity in the real estate that is being purchased or refinance. Generally, borrower needs a minimum FICO of 680 and a maximum loan to value of 80%. Programs exist for greater than 80% LTV's but they come with higher interest rates.

Some stated income programs require six months of proposed monthly payments in the form of cash reserves in bank accounts.

Borrowers with high FICO scores and low LTV's can generally obtain more favorable interest rates. These stated income programs are priced based upon the assessed risk of the loan.

The lowest perceived risk programs are priced about 3/8ths to 1/2% above the interest rate of a conventional loan.

There are stated income programs also for salaried borrowers.

No ratio and no asset loans are programs in which the income is not stated and the assets listed on the loan application are not verified. These loans are perceived as being more risky and are priced at higher interest rates than the stated income loans. Generally, the FICO scores and the LTV's are also more restrictive. This program has lost popularity because of widespread misuse. It is no longer available. Information about this discontinued program is only provided in the event the reader may want a historical reference.

One word of caution is necessary. Because income is not verified, borrowers are tempted exaggerate their incomes. The lenders certainly realize this fact and many of them have the borrowers sign a Form 4506 which is a "Request for Copy or Transcript of Tax Form." This form allows the lender to go directly to the Internal Revenue Service and obtain the borrowers last Federal Income Tax Return. Not all lenders require Form 4506. Your mortgage banker should be able to select the best lender for you. Furthermore, some lenders use an industry website to obtain estimates of salary ranges for a variety of job titles.

Subprime loans are also called "B, C and D" loans. These letter designations are similar to school grades. That is conventional and VA loans would be A+ and A loans and FHA would be A+, A or A- loans. A loan which is in foreclosure would carry a D grade. This grading of creditworthiness allows lender to make loans that are perceived to be of greater risk and which carry a higher interest rate.

Subprime loans are for borrowers with moderate to substantially impaired credit. Impaired credit can be in the form of Judgments or Collection Agency items on the credit report. Other examples of impaired credit are late payments of 30 to 90+ days past due, foreclosures, repossessions, settlements, and bankruptcies.

Credit (FICO) scores can be incredibly complicated and difficult to interpret. Just like conventional lenders, subprime lenders rely almost exclusively on FICO scores for loan decisions and loan pricing.

Subprime lenders enter the market for borrowers whose credit scores are below 620. However, Subprime lenders have loan products for those whose credit scores are 680 or higher. Subprime loans can go to borrowers whose scores are as low as 560, and there may be lenders in the marketplace who will approve borrowers whose scores are below 560.

Subprime lenders compensate for lower FICO scores primarily by reducing or lowering the required loan to value ratios. (LTV's) That is, a borrower whose middle FICO is 580 may be able to obtain a loan with an LTV of 90%, whereas a FICO score of 525 may only qualify for a 65% LTV. Another way Subprime lenders compensate for risk is with the interest rate of their product.

Subprime lenders have an array of different products and one of the most popular is the 2/28. This loan is a fixed rate for the first two years and then an adjustable rate for the remain 28 years of a fully amortizing 30 year loan. Generally, the interest rate for the first two years is manageable (certainly not usurious) but the rate increases dramatically once the loan converts to its adjustable rate feature. Similar loans are the 3/27 and 5/25 loans. Most but not all Subprime loans carry 2 to 5 year pre-payment penalties. New products out now offer a 3/37. (i.e. a 40 year amortization)

The theory behind 2/28 to 5/25 loans is that the borrowers have had a temporary setback in their financial condition that caused their credit scores to decline. The borrowers need time (2 to 5 years) to repair and restore their scores. After 2-5 years have elapsed, the scores should return to reasonable levels and the borrowers will again qualify for conventional loans. The disadvantage of this approach is that the Subprime loan must be refinance with an additional set of closing costs being paid. Also, there is no guarantee that the borrowers can repair and restore their credit scores, thus locking them into a high interest rate loan.

Subprime lenders offer an array of products for home purchases. Some Subprime lenders offer 100% financing for purchases. These programs generally require 580 or greater FICO scores. Most of these programs offer a combination of an 80% LTV first mortgage and a second mortgage for the balance of the purchase price. The blended rate on the two mortgages typically can vary from 7% to 9.0+%.

Subprime lenders also offer programs that allow the sellers to finance part of the purchase price. The most popular of these programs is called the 80/10/10. This translates to an 80% LTV first mortgage, and a seller financed second mortgage of 10% with the buyer paying the final 10% of the purchase price in cash. This seller financed purchase works best in soft real estate markets.

Subprime lenders have a variety of programs for stated income borrowers. In addition to the standard stated income previously discussed, they offer hybrid programs. With one program the borrower provides one or two years of bank statements and the deposits shown on the statements are used to verify income. Some of these hybrid programs are also applied to business checking account statements but the lenders are more selective with them.

Because of the recent meltdown of the credit markets due to defaulting subprime loans, this market is almost extinct.

FHA loans are the only avenue available to borrowers with impaired credit. By the late spring of 2008, FHA loans constituted 40% to 50% of all approved mortgages.

h. Hard Money Loans

Hard Money Loans are those that are based solely on the value of the property. This term generally refers to loans made to borrowers who are in a foreclosure. Foreclosure is defined as the time between when a borrower receives a "Notice of Election and Demand" (after borrower is more than 90 days late on their loan payment) until the end of the redemption period. Some hard money loans require no qualifying and have no minimum FICO score. However, with the change in Colorado law, some lenders are beginning to request documentation other than an application and appraisal.

Generally the lender will not loan more than 65% Loan-To-Value. (LTV) Exceptions to 70% LTV are available.

An alarming number of Hard Money Lenders are predatory. That is, they want the property and will take actions to get the property through a second foreclosure. The borrower must use extreme care in selecting a mortgage banker/loan officer in this situation. Please call the author of this article (Mike Cotter 877 656-8522) to discuss in detail the risks of hard money loans.

The preceding has been a detailed explanation of the process and methods employed in obtaining a mortgage. The process is very similar for either a purchase or refinance. We covered applications, qualifying ratios, credit reports, and appraisals. While this information is not rocket science, it is very detailed and requires considerable management attention on the part of the mortgage banker. It is so detailed, that the borrower should not hesitate to ask his/her loan officer to repeat any of the information that is being disseminated to them.

The description of the basic loan products should help prospective loan applications decide what product might be best suited for them.

When shopping for a loan remember this, the mortgage broker's job is to first obtain a loan commitment and then to obtain the most favorable interest rate for the borrower.

X. ABOUT THE AUTHOR

Mike Cotter has been a professional lender for over 36 years. He began his career in the commercial banking industry in 1972 and steadily progressed to become Vice President of Retail Banking with a major Denver bank. In 1982 he opened his own commercial bank and served as President and CEO. In 1992 he left commercial banking for the mortgage banking. He has been a successful mortgage banker / mortgage broker for over 16 years and he owns his own company.

Mike’s banking and mortgage banking career has enabled him to lent money to both consumers and to businesses for equipment financing, working capital lines of credit, business acquisitions, home, investment, and apartment acquisitions as well as real estate purchases and refinances. He has successfully completed over 5,000 “deals” in his career.

Mike holds both a Master’s Degree in Business Administration and a Master’s Degree in Banking.

XI. Resume of Author

Originate first and second mortgage loans for residential and investment properties. Originate FHA, VA, Conventional, Jumbo, Subprime and niche products such as stated income, no asset and hard money loans. Owns and operates web site www.micottmortgage.com

As CEO, was responsible for the growth and management of a full service commercial bank. Hired, trained, and supervised a staff of 22 employees including 7 officers. Primary responsibility included loan origination, business development, operations, budgeting and supervision. Operated and directed the fastest growing and second most profitable bank of a 12 bank group.

Opened new bank charter and grew bank for seven successful years in spite of severe Colorado recession which began in 1985. Elected and served on bank's Board of Directors and on Executive Committee for a five-bank chain.

I. INTRODUCTION

X. ABOUT THE AUTHOR