Loan Qualifying Process

Loan Qualifying

• Preapproval: A formal process where a buyer determines their maximum loan amount, useful for negotiations. The lender verifies income and credit, similar to a full application but without appraisal or title report. This helps buyers know their maximum price limit and avoid surprises during negotiations. A potential disadvantage is that if a lower priced home is desired, the preapproval amount could harm negotiations with the seller. The process involves a loan application submission and income/credit documentation. Lenders evaluate this information and issue a letter stating the maximum loan amount. This letter has an expiry date and is a valuable tool during negotiations.

• Underwriting Process: Evaluates a loan application to determine the borrower's likelihood of repaying and if the property can cover losses in default. Standards are set by Fannie Mae and Freddie Mac, making non-conforming loans less easily sold on the secondary market. Underwriting uses income, net worth, and credit reputation; and is often handled by software.

  • Automated Underwriting System (AUS): Analyzes applications, making recommendations, but the final approval is still made by a human underwriter.

• Income Analysis: Evaluating the borrower's steady income is key for loan approval.

  • Acceptable income sources: Salary (at least 2 years), self-employment (with adjustments), other recurring/regular employment, secondary sources (pension, social security), spousal/child support (reliable and long-term), public assistance, and investment income (dividends/interest). Co-signer income can help qualify.
  • Unacceptable income sources: Unemployment (short-term), family member income, temporary/seasonal work (exceptions apply).
  • Income Verification: Using forms from employers, W-2s, pay stubs, tax returns, court records (support), leases (rental income) over the past two years to verify income.
  • Income Calculation: Converting income to monthly terms from different pay schedules (hourly, bi-weekly, twice monthly).
  • Income Ratios/Qualifying Standards: Debt-to-income and housing expense-to-income ratios ensure enough funds for loan and expenses; these measure if calculated income is enough for the loan.

• Net Worth: Total value of assets minus liabilities (debts). Demonstrates the borrower's ability to cover transaction costs and handle emergencies. Liquid assets are prioritized.

  • Calculating Net Equity: Appraised value (or sales price) minus liens minus selling costs. This shows the net proceeds from selling a current home, acting as a liquid asset.

• Credit Reputation: Reviewing credit history for negative information (delays, refinancing, collections, repossessions, foreclosures, bankruptcy) over the last 7-10 years. High FICO scores (over 700) are favorable. Lenders use credit scores for loan risk assessment and interest rates.

• Low-Documentation Loans: Lenders may relax income and asset requirements for borrowers with good credit and large down payments. Potentially higher interest rates; less common due to the 2000s foreclosure crisis.

• Subprime Lending: More flexible underwriting standards for riskier borrowers; higher rates, fees, and penalties (prepayments, balloon payments, negative amortization). Lenders actively involved in this lending are often conscious of non-conforming loan policies.

• Choosing a Loan:

  • Truth in Lending Act (TILA): Requires lenders to disclose loan costs, including APR, using standardized forms.
  • Finance Disclosure Laws (Federal and State): Federal and state laws regulating real property loans, seller financing, and advertising related to these. State laws vary widely. Understand terms and costs (interest rates, loan term, down payment, payments, and investment opportunities).
  • Locking in the interest rate: Often involves a fee for rate protection until closing. If rates drop, lenders may still charge the locked-in rate.

Predatory Lending

• Unfair practices by lenders to profit from unsophisticated borrowers:
  • Steering: Guiding buyers toward more expensive loans, potentially inappropriate for the borrower's financial situation.
  • Fee packing: Charging unnecessary rates, points, or fees.
  • Loan flipping: High fees from repeated, unnecessary refinancings.
  • Inadequate underwriting: Making loans without proper borrower evaluation.
  • Balloon payment abuses: Partially amortized or interest-only loans without disclosing balloon payment requirements.
  • Fraud: Using misrepresentation or fraudulent means to induce borrowers into loan agreements.

Finance Disclosure Laws

• TILA: Federal law detailing loan costs, including APR.
• State Finance Disclosure Laws: Regulate real estate, seller financing, and advertising according to specifics based on each state.

Explore the essential elements of loan qualifying, including the preapproval process, advantages and disadvantages, and the underwriting workflow. Understand how income analysis and automated systems play a crucial role in determining a borrower's eligibility for a loan. Ideal for those entering the mortgage market.