© 2012 Rockwell Publishing Financing Residential Real Estate Lesson 7: The Financing Process

© 2012 Rockwell Publishing

Financing Residential Real Estate

Lesson 7:

The Financing Process


Introduction

This lesson will cover:shopping for a loanapplying for a loanapplication processingclosing


Shopping for Loan

For home buyers, shopping for mortgage loan involves:

assessing wants, needs, financeschoosing lendercomparing rates, feesevaluating financing options


Shopping for Loan

To establish price range before house hunting begins, buyers should find out what financing they qualify for.

Two ways of doing that:prequalifyingpreapproval

Assessing buyer’s position


Assessing Buyer’s Position

Prequalifying:informal process (done by real estate

agent or online mortgage calculator)rough estimate of maximum loan amount

Preapproval:formal process (done only by lender) specific maximum loan amount

Prequalifying vs. preapproval



For preapproval, buyer must:complete loan applicationprovide documentation of income,

assets, debts, credit history

Preapproval



Lender gives buyer preapproval letter, agreeing to loan up to specified amount.

Valid only for limited period.

Advantages of preapproval:tool in negotiations with sellersstreamlines closing process

Preapproval



Prequalifying still useful for buyers who aren’t ready to apply for preapproval.

Knowing how to prequalify buyer can also help agent understand underwriting process.

Prequalifying



Basic steps in prequalifying:

1. Apply income ratios to monthly income to find maximum monthly payment. Must cover principal, interest, taxes,

insurance (PITI).

2. Subtract percentage from PITI figure to find maximum principal and interest payment.

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.

How to prequalify buyers


Choosing Lender

Several ways to find lender:researchreferralsmortgage brokerbuyer’s bank

Identifying prospects


Choosing Lender

Involves reviewing print, online, other media advertisements.

Should be followed with phone calls.Talk to loan officers.

Newspaper may have mortgage comparison chart.

Research


Choosing Lender

Often best way to find good lender.Ask family, friends, co-workers.Talk to real estate agent.

Agents should not accept referral fees.

Referrals


Choosing Lender

Mortgage broker specializes in bringing buyers and lenders together.

Presents buyers with options offered by multiple lenders.

Research still necessary to find goodbroker.

Mortgage broker


Choosing Lender

Banks sometimes offer special financing to established customers.

One location for handling all financial matters.

Buyer’s bank


Choosing Lender

Buyers should talk to 3 or 4 lenders before submitting application.

Ask each lender for written good faith estimate of loan costs, closing costs.

Good loan originator puts buyers at ease, explains process thoroughly.

Interviewing prospective lenders


Choosing Lender

Buyers should also consider lender’s reputation.

Expertise, efficiency, stability, honesty.Get references from lender’s recent

customers.Look for customer satisfaction

information online.

Interviewing prospective lenders


SummaryPrequalifying & Choosing 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.

In addition to interest rate, cost of loan may include:loan origination feediscount pointsmiscellaneous chargesmortgage broker’s fee


Loan Costs

Point: percentage point. 1 point = 1% of loan amount.Some lenders use “points” to refer to

origination fee and discount points together.

Others use “points” to refer only to discount points.

Points


Loan Costs

Origination fee: pays lender’s expenses, such as staff compensation, facilities costs, other overhead.

Charged in almost every mortgage transaction.

Typically around 1% of loan amount.Paid at closing, usually by borrower.

Loan origination fee


Loan Costs

Lump sum paid at closing to increase lender’s upfront yield (profit) on loan.

In exchange for upfront payment, lender charges lower interest rate.

May save borrower money in long run,depending on how long loan in place.

Discount points


Loan Costs

Discount points charged can vary depending on market conditions, other factors.

Might charge 4 to 6 points for1% interest rate reduction.

Discount points


Loan Costs

May be paid by buyer or seller.

Buydown: paying discount points to “buy down” buyer’s interest rate.

When buyer pays points, pays lender in cash at closing.

When seller pays points, amount withheld from loan, deducted from seller’s proceeds.

Discount points


Loan Costs

Lenders often charge borrowers other fees, such as:

application feedocument preparation feeunderwriting fee

Miscellaneous fees


Loan Costs

Buyers working with mortgage broker usually charged mortgage broker’s fee.

May be separate fee or included in points quote for loan.

Broker gets loan at wholesale price, marks it up to retail price, keeps overage as fee.

Mortgage broker’s compensation


Comparing Cost of Loans

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 requiring lenders to disclose loan costs in format that makes comparison easier.

Truth in Lending Act



APR most important TILA disclosure.APR expresses relationship between

amount financed and total finance charges as a percentage.

To determine which of two loans is more expensive, compare APRs, not just interest rates.

Annual percentage rate



Another key TILA disclosure. Total finance charge includes:

interestorigination feediscount points (by buyer)mortgage broker’s feefinder’s feeservice feemortgage insurance/guaranty fees

Total finance charge



Does NOT include:title insurance costscredit report chargesappraisal feediscount points paid by seller

Total finance charge


Loan Costs

Some lenders offer no-fee loans or low-fee loans.

No major lender fees (origination fee, points).

Only financing charge is interest.Interest rate often much higher.Helpful for buyers with little cash for

closing.

No-fee or low-fee loans


Evaluating Financing Options

First-time buyers may benefit from home buyer counseling before deciding what financing option is best for them.

Home buyer counseling



Department of HUD developed Housing Counseling Assistance Program.

Open to anyone looking for home or applying for mortgage.

Also for renters and people who already own home.




Program intended to educate people about home ownership responsibilities:

making mortgage/rent paymentsmaintaining homeavoiding foreclosure/eviction

Counselor would prepare action plan to help buyer achieve goals.




Federal funding for the program was eliminated in mid-2011.

Legislation to restore funding currently being considered.



SummaryLoan Costs & 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 Loan

After buyers have chosen lender, next step is to apply for loan.

Loan interview: buyers talk with loan originator.

Originator helps buyers:choose best financing optionprepare application

Loan interview


Loan Interview

During loan interview, originator may enter information into automated underwriting system.

System provides preliminary evaluation of what buyers are likely to qualify for.

Does not guarantee preapproval.

Prequalifying during interview


Loan Interview

Loan originator may require deposit to cover certain expenses:

application feecredit report feeother preliminary charges

Deposit


Loan Interview

If buyers have already signed purchase agreement, loan originator reviews contract.

Main concerns:terms of financing contingencyclosing date

Contract and closing date


Loan Application Form

First section of form asks about:type of loanloan amountloan terminterest rate

Type and terms of loan



Second section asks for:property address/legal descriptionpurpose of loan (purchase, construction,

refinancing)how buyer will take titlesource of downpayment

Property information and purpose



Third section asks about applicant(s):namesocial security numberdate of birthyears of schoolingmarital statusNumber, age of any dependents

Borrower/co-borrower information



Each applicant must also provide:name and address of employernumber of years at jobposition heldtype of business

Employment information



This section asks about:primary employment incomeovertime, bonuses, or commissionsother sources of incomecurrent rent or mortgage payment

Income and monthly housing expense



Assets may include:good faith depositmoney in bankinvestments

Liabilities may include:car loancredit cardsalimony/child support

Assets and liabilities



Application also asks for information about transaction, including:

purchase pricecost of landprepaid expensesclosing costs

Details of transaction



Applicants must answer questions about:outstanding judgments, lawsuitsbankruptciesforeclosures or deeds in lieualimony/child supportcitizenship

Declarations



Applicants also must state:whether any portion of downpayment

was borrowedwhether property is to be primary

residenceany other property owned in last three

years

Declarations


Applying for Loan

Truth in Lending Act (TILA):APR, total finance charge, lender’s

charges

Real Estate Settlement Procedures Act (RESPA):

good faith estimate of closing costsbooklet about closing processmortgage servicing disclosure

Federal disclosure requirements


Applying for Loan

Lenders must provide all disclosures within 3 business days after application submitted.

Disclosures not required if application rejected before 3-day deadline.

If any costs change, new disclosuresmust be made before closing.

Federal disclosure requirements


Applying for Loan

Sharp increase in rates might increase monthly payment so buyers no longer qualify. Should ask lender about lock-in.

Lock-in: lender guarantees certain interest rate for specified period.

Float: interest rate will move up or down with market interest rates until closing.

Locking interest rate


Applying for Loan

Lock-in period should extend beyond expected loan processing time.

But lender can charge locked-in rate if market rates have gone down.

Locking interest rate


SummaryApplying for Loan

• Uniform Residential Loan Application

• 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 employers, bankscredit reports, credit scores obtainedif purchase agreement exists:

appraisal orderedtitle report ordered


Application Processing

After verification forms returned and reports received, loan processor puts together loan package and sends it to underwriting department.


Underwriting Decision

Underwriter reviews loan package, applies appropriate qualifying standards to buyers.

May use automated underwriting system.Loan is either:

approvedrejectedapproved subject to conditions



If loan denied, lender must provide explanation.Written statement within 30 days.

Buyers may want to:apply to different lenderapply for different type of loanwait and take steps to improve finances

Rejection



Conditional commitment commits lender to making loan if buyers:

fulfill specified conditions, and/or submit additional documentation.

Conditional commitment



Preapproval is form of conditional commitment. Approval contingent on:

satisfactory appraisalsatisfactory title report

Preapproval



States that lender will loan buyers up to specified amount to buy house.

Expires at end of specified period.Lender may agree to extension if buyers’

information reverified.

Preapproval letter



When all conditions for approval are satisfied, lender issues final commitment letter.

Confirms loan terms.Has expiration date.

Final commitment


Closing Loan

Last stage of financing process coordinated with closing of property sale.

In many areas, closings handled through escrow.

Escrow: neutral third party holds money and documents for buyer and seller until transaction ready to close.

Escrow


Closing Loan

Closing agent (escrow agent):makes sure all requirements are taken

care of before closing datedisburses purchase price, delivers deed

when conditions in purchase agreement are satisfied

Closing agent


Closing Loan

May be:independent escrow agentemployee of lendertitle companylawyerreal estate broker

Closing agent


Closing Loan

Clearing and insuring titleInspections and repairsLoan documents issued and signedFunding loanPreparing settlement statementsRecording documentsDisbursing funds

Steps in closing process


Steps in Closing Process

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 owedrelease obtained and recorded

Clearing and insuring title



Lender will require extended coverage title insurance policy to protect its lien priority.

Usually paid for by buyer.

Clearing and insuring title



Lender may require inspections or tests, such as:

pest control inspectionsoil percolation testflood hazard inspection

Based on inspection report, lender decides whether to require repairs or other corrective steps.

Inspections and repairs



Once loan has been approved, lender forwards loan documents to closing agent.

Buyer:deposits funds required for closing into

escrowsigns loan documents

Loan documents and buyer’s funds



Lender often requires buyer to make deposit into impound account at closing.

Ensures taxes, 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.

Impound account



Buyer will also pay interim interest (prepaid interest) at closing, since:

buyer’s first payment is not due on first day of month immediately after closing, and

mortgage interest paid in arrears, after it accrues.

Interim interest



Funding the loan: when lender releases buyer’s loan funds to closing agent. Happens only after:

buyer signs loan documents,lender reverifies buyer’s employment and

other information, andany other conditions imposed by lender

have been satisfied.

Funding loan



Final settlement statements for buyer and seller itemize charges, credits for each party.

RESPA requires closing agent to:use Uniform Settlement Statement

formallow buyer to review statement at least

one day before closing if buyer asks

Settlement statements



Closing agent records deed, other documents, disburses funds to parties.

Title company issues policies.Lender gives buyer copy of final loan

documents.Buyer gives lender copy of hazard

insurance policy.

Final steps


SummaryApplication Processing & Closing

• Loan package• Conditional commitment• Preapproval• Final commitment• Closing agent• Escrow• Interim interest• Impound account• Funding loan

Documents

© 2012 Rockwell Publishing Financing Residential Real Estate Lesson 7: The Financing Process