Mortgage Broking

Chapter 6

Managing the Loan Application Process

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Understanding Lender’s Loan Decision

 Traditional lenders such as banks tend to have more stringent criteria.

 Non-conforming lenders are a lot more flexible.

 Mortgage managers are somewhere in-between.

 The prospective lender will always review the borrower’s creditworthiness.

 All questions that are found in a mortgage application form are always motivated towards obtaining information that will give the lender a solid understanding of borrower’s creditworthiness.

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Fundamental Issues determining Client’s

Creditworthiness  The ‘Five Cs’ of credit is at the heart of every credit

decision. These are: – Capacity — How borrower intends to repay loan;

– Credit (or Capital).— Credit history of borrower;

– Collateral — ‘Security’ hedge against loan default;

– Conditions — Local and economic conditions, and – Character — General impression borrower makes

on prospective lender.

Loan-to-Value (LVR) Ratio  All lenders have minimum and maximum limits for

loans. The minimum amount is usually determined by the average economic cost of assessing and administering a loan.

 The maximum amount depends on the borrowing capacity and assessed risk-level of the prospective borrower. Mostly, loan-to-value ratio is the key determinant of the maximum loan amount that a lender would approve.

 The loan-to-value (LVR) ratio is an indicator of borrower’s leverage at the point when the loan application is filed.

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Loan-to-Value (LVR) Ratio…

 The LVR calculation compares the value of the desired loan, with the market-value of the property. *An example of such a calculator- www.mortgagechoice.com.au/home-loan-calculators/lvr- calculator/

 In a refinancing situation, the LTV depends on the requested balance of the new loan and the market value of the property.

 If the new loan is larger than the original loan, the transaction is referred to as ‘cash out refinancing’. Otherwise, the transaction is described as ‘rate and term refinancing’.

 Apart from the LTV ratio, the location of a property is also important. 306

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 Calculation of LVR: Loan Amount ÷ Purchase Amount = Loan-to-Value Ratio

 For a loan of $130,000 borrowed for a property valued at $150,000, the LVR would be:

$130,000 ÷ $150,000 = .8667 or 87%

Loan-to-Value (LVR) Ratio… *Not in Notes*

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Factors affecting the Loan Price

 Mortgage brokers cannot predict all price movements.  They need to understand how the prices are determined

via the business Profit/Loss statement: – Revenue: such as fees and commissions. – Business expenses: such as salaries, operational costs, taxes, etc.

 The interest rate should cover not only the borrowing cost of the financial institution and the cost of risk mitigation, but business expenses and profit.

 When determining the interest rate, lending institutions will consider two key factors: – Official cash rate set by the Reserve Bank of Australia. – Risk-based pricing.

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Official Cash Rate Changes in Australia

Date % Date % 6-Feb-08 7·00 2-Jul-08 7·25 4-Feb-09 3·25 8-Jul-09 3·00 3-Feb-10 3·75 7-Jul-10 4·50 2-Feb-11 4·75 6-Jul-11 4·75 8-Feb-12 4·25 4-Jul-12 3·50 6-Feb-13 3·00 3-Jul-13 2·75 5-Feb-14 2·50 2-Jul-14 2·50 4-Feb-15 2.25 8-Jul-15 2·00 3-Feb-16 2.00 8-Jul-16 1·75

29 January 1990 — 17.50% Source: http://www.rba.gov.au/statistics/cash-rate/

*Updated*

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Standard Variable Home Loan Interest Rates Year % Year % July-2005 7·30 July-2011 7·79

July-2006 7·30 July-2012 6·99

July-2007 8·05 July-2013 6·15

July-2008 9·35 July-2014 5·53

July-2009 5·65 July-2015 5·21

July-2010 6·91 July-2016 5·10

Source: http://www.loansense.com.au/historical-rates.html

*Not in Notes*

 Lenders add their margin of approximately 1.8%–2.5% independent of the cash rate.

Risk-Based Pricing  The riskier the loan, the more credit-spread a lender

would put on top of the cash rate.

 When assessing the risk-level of a borrower, a lender will consider the underlying mortgage, loan-to-value (LVR) ratio, the borrower’s credit history, current financial position and general market conditions.

 Secured loans will be subject to lower interest rates than unsecured loans.

 A loan with reduced documentation is riskier than one with full documentation and will be more expensive.

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Risk-Based Pricing…

 Options or features coming with the mortgage loan may increase the cost of the loan.

 Lending institutions have developed strategies to mitigate credit risk including: – lending only a portion of the value of the collateral

security rather than the entire amount – underwriting the collateral security with an insurance

policy, such as LMI – confirming the borrower’s capacity to meet

the repayment schedule – completing a credit check to verify the

borrower’s reliability 312

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Preparation of a Loan Application

 A typical loan application involves the following stages: – Preliminary Stage

– Application

– Approval

– Settlement.

Preliminary Stage  The relationship between broker and client generally

begins with an initial interview where they meet to discuss the potential loan.

 At this stage, the client may or may not bring the necessary documents to put a loan application.

 This initial meeting may end up with either a pre-qualification or a pre-approval.

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Pre-Approval versus Pre-Qualification

 It is often difficult for a buyer to translate a monthly payment into a specific maximum mortgage amount because of other factors such as: – deposit percentage, – mortgage insurance, – other fees and taxes,

– interest rates, etc.

 Both the pre-approval and pre-qualification processes aim to eliminate this uncertainty.

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Pre-Approval versus Pre-Qualification…

 The client can obtain a pre-qualification letter from the mortgage broker or from a prospective lender by providing some basic financial information.

 At this stage, there will be no verification for client’s information, therefore the terms and conditions on this letter are indicative only.

 A pre-approval letter, requires verification of the buyer’s financial information.

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Pre-Approval versus Pre-Qualification…

 The lender will ask for documentation: – to confirm prospective borrower’s employment, – the source of deposit, and – other proof of the borrower’s financial circumstances.

 A pre-approval is more time-consuming than a pre-qualification and carries more weight, but is: – not binding on the lender. – subject to an appraisal of the house the

borrower wants to purchase and, – time-sensitive.

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Pre-Approval versus Pre-Qualification…

 With most pre-approvals, there are conditions that need to be met. These include: – finding a suitable property – receiving a registered valuation – taking out mortgage insurance (if applicable).

 As a rule-of-thumb, a pre-approval will typically cost a borrower a nominal amount for processing and assessment fees but borrowers will: – know how much they can borrow, and – how much they can spend.

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Pre-Approval versus Pre-Qualification…

 The most common pre-approval conditions are: – Valid for 3 months and is intended as a guide only. It should

not be used to purchase a property at an auction.

– Does not apply to ‘low doc’ loans.

– Does not take into account the value of intended property. (Cannot borrow more than 100% of the property value.)

– Amount may differ from borrower’s final approved loan amount, especially if a borrower requires a line of credit or provides certain types of security such as a mortgage over an inner city apartment.

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Pre-Approval versus Pre-Qualification…

– Has not taken into consideration the First Home Owner Grant or any other government grant and has not factored in Lender’s Mortgage Insurance.

– A full home loan application is required to gain formal home loan approval.

 A home loan pre-approval: – Provides buyers with an excellent guide on how

much they can afford to spend and allowing them to negotiate more strongly on price.

– No window period while a buyer’s loan application is processed.

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Pre-Approval versus Pre-Qualification…

– It is possible to shorten a 30-day closing to two or three weeks.

– Sellers know buyers are financially qualified to obtain the financing.

– A buyer might feel more confident about making an offer in the knowledge that they will be able to obtain a mortgage.

– Signals to the real estate agent that the buyer is a well-qualified one who is serious about purchasing a home.

– Buyers can spend their time examining the right homes.

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Gathering Client’s Information

 Collecting information is required to carry-out an appropriate analysis about the client; it is also a legislative requirement.

 A mortgage broker should collect all the respective documents from a prospective client and present them to the prospective lender. – the residence addresses for the past few years. – all bank account details along with account

statements which are required (if the prospective buyer has both checking and savings accounts, they should submit statements for both accounts).

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Gathering Client’s Information…

– credit card bills for the past few billing periods.

– documents to show payment history and amounts of revolving debt.

– information on other consumer debt such as car loans, furniture loans, student loans.

 Most lenders will request documents showing employment history (such as pay slips, group certificates, etc., including any overtime, commission or bonus income) for the last few years, including dates the borrower was employed, and the name, address and phone number of employer.

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Gathering Client’s Information…

 Sometimes, the bank requests an employment verification form.

 If client is self-employed, contractor or works on commission basis, the lender may request additional documentation of income: – tax returns (up to three years), – copies of balance sheet and income statements

for at least the last two years.

 A mortgage broker should collect all the respective documents from a prospective client and present them to prospective lender.

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Understanding Client’s Needs

 A broker will explain and discuss available loan alternatives, their characteristics and features.

 While the comparison rate can give a good idea of the true cost of the loan, the broker should also consider the money-saving features a client might get.

 A loan that has a slightly higher comparison rate against one with a lower comparison rate, but no flexible features, might be more appropriate for the client. – Redraws, direct debit, and flexible repayment can make a

huge difference to overall cost and convenience of the loan.

Providing Alternatives  Some brokers will make their selection from a panel

of many lenders, offering many products.

 Other brokers, while representing that they can ‘arrange finance’, will forward virtually all loan applications to a few selected lenders (or, indeed, may channel all applications to one particular lender), and operate as de facto agents for those lenders.

 Clients expect their broker to provide a wide range of loan products from a variety of independent lenders.

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Providing Alternatives…

 To provide the most appropriate alternatives to their clients, mortgage brokers should undertake continuous research about current lending trends, including the average rates being given out by lenders.

 When one looks at the rates advertised on a lender’s website, they are generally seeing the best numbers they offer.  All borrowers may not qualify for them.

 Generally, making at least three applications is recommended so that a comparison would be possible.

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Providing Alternatives…

 Not everyone qualifies for the best rates. – Each individual lender has its own definition of a ‘well-

qualified borrower’.

 When shopping for a mortgage loan and comparing lenders to one another, a broker could find ten different quotes from ten different lending institutions.

 When making the final decision, clients focus on three of the most important considerations: – Interest rates – Other costs and fees – Penalties of any kind

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Approval Stage  All pre-settlement conditions of finance approval are

confirmed with the lender and the various parties to settlement are communicated with to confirm that documentation and any other settlement issues are in order.

 If they find anything wrong, it could slow down the process or possibly derail it altogether.

 In the case of a second (or more) mortgage advance, confirmation is obtained that the prior mortgagee has consented to the subsequent mortgage.

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Approval Stage…

 The next major step is where the lender sends a professional home appraiser out to evaluate the property.

– The lender wants to make sure the home is worth the amount the borrower has agreed to pay for it.

– In the event that borrower defaults on the loan the lender will have to take-on the property and sell it off through an auction or other means.

 The mortgage broker should see that all documents are checked to ensure they are correctly executed, witnessed and dated before sending to approving personnel.

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Processing Applications for Credit

 Every lender has their own set of guidelines and criteria under which they are prepared to approve a loan facility.

 Within such organizations, file and record movements are typically monitored and recorded.

 Procedures ensure that documentation is produced in accordance with industry, organization and legislative requirements and timeframes as well as organizational policy and procedures. – Assuming all is in order, the agreement between the

borrower and lender regarding the terms and conditions of the mortgage will be signed at this stage.

Settlement Stage  The real estate closing (also known as ‘settlement’) is

the official transfer of property ownership from the seller to the home buyer. – The steps taken vary from State-to-State

 Once all parties sign the contracts, transfer documents are drawn and executed and then submitted for stamp duty assessment and payment. – Usually in the sale of real property a contract

term is about 28 days.

 Upon settlement of the purchase contract the parties will come together and exchange documents and money and the deal will be officially closed.

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Settlement Stage…

 Ownership of the property is formally transferred to borrower and registered with the Titles Office by the purchaser or their solicitor.

 Closing costs are the total cost of completing the transfer of ownership of a house. – These costs do not include the purchase price of

the home. – They are the extras (fees and expenses) aside

from the purchase price.

 There is usually little need for a continuing relationship between the borrower and the broker after that time.

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Industry Background

 ‘Good’ brokers will see 2–3 clients per day.  An average brokers will be looking at closing

4 sales per month.  The appointment will generally take less than 1 hour

(clients won’t generally want to spend longer than that).  Average new home loan is $357,200 (Aus [Feb]*);

$437,100 (Syd).  Average loan re-payments 31.0%† of average

family income (39.4% Syd‡). *http://www.yourmortgage.com.au/article/average-home-loan-size-falls-across-australia-214965.aspx †http://www.sbs.com.au/news/article/2015/04/27/how-much-your-income-going-your-mortgage ‡ http://www.domain.com.au/news/housing-affordability-crisis-takes-hold-as-borrowers-start-to-feel-the-pinch-

20160304-gnb2c7/

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Assessments True/False

Short Answer Case Study and Questions

Role Play Online Quiz (replaces oral quiz)

Chapter 6

Case Study and Role Play

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Role Play  You will play yourself as a Mortgage Broker and

will meet Peng and Mia for the first meeting.

 Peng and Mia have already sent you their documents and you are offering them your advice.

 The specific areas to be covered in the role play are outlined in your learner manual.

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