Real estate finance 6

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Financing Residential Real Estate

Lesson 7:

The Financing Process

Introduction

This lesson will cover:

shopping for a loan
applying for a loan
application processing
closing

Shopping for Loan

For home buyers, shopping for mortgage loan involves:

assessing wants, needs, finances
choosing lender
comparing rates, fees
evaluating financing options

Shopping for Loan

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

Assessing buyer’s position

Assessing Buyer’s Position

Preapproval:

formal process performed by mortgage broker or lender

For preapproval, buyer must:

complete loan application
provide documentation of income, assets, debts, credit history

Preapproval

Assessing Buyer’s Position

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

Valid only for limited period.

Advantages of preapproval:

tool in negotiations with sellers
streamlines closing process

Preapproval

Assessing Buyer’s Position

Prequalification:

informal process performed by real estate agent or using online mortgage calculator
provides rough estimate of maximum loan amount
rarely done anymore

Prequalification

Choosing Lender

Several ways to find lender:

research
referrals
mortgage broker
buyer’s bank

Identifying potential lenders

Choosing Lender

Involves reviewing print, online, other media advertisements.

Followed up with phone calls.
Talk to loan officers.

Newspaper may have mortgage comparison chart.

Research

Choosing Lender

Referral often best way to find good lender.

Ask family, friends, co-workers.
Talk to real estate agents.
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 good
broker.

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 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 mortgage broker's recent customers.
Look for customer satisfaction information online.

Interviewing prospective lenders

Summary
Preapproval & Choosing Lender

Preapproval
Preapproval letter
PITI
Loan originator
Loan officer
Mortgage broker
Referral
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 fee
discount points
miscellaneous charges
mortgage 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, cost of facilities, other overhead.

Charged in almost every mortgage
transaction.
Typically around 1% of loan amount.
Usually paid 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 and other factors.

Might charge 4 to 6 points for
1% 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, buyer 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 fee
document preparation fee
underwriting fee

Miscellaneous fees

Loan Costs

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

Fee may be one or two percent, but generally won’t make loan more expensive.
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 using loan estimate form.

Truth in Lending Act

APR most important TILA disclosure.

APR expresses relationship between amount financed and finance charge as a percentage.
To determine which of two loans is more expensive, compare APRs, not just interest rates.

Annual percentage rate

Truth in Lending Act

Finance charge is another key TILA disclosure. It includes:

interest
origination fee
discount points (paid by buyer)
mortgage broker’s fee
finder’s fee
service fee
mortgage insurance/guaranty fees

Finance charge

Truth in Lending Act

Does NOT include:

title insurance costs
credit report charges
appraisal fee
discount points paid by seller

Finance charge

Loan Costs

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

No major loan 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

Evaluating Financing Options

Department of Housing and Urban Development (HUD) administers Housing Counseling Assistance Program.

Open to anyone looking for home or
applying for mortgage.
Also for renters and people who already own home.

Home buyer counseling

Evaluating Financing Options

Program intended to educate people about home ownership responsibilities:

making mortgage/rent payments
maintaining home
avoiding foreclosure/eviction

Counselor may prepare action plan to help buyer achieve goals.

Home buyer counseling

Summary
Loan Costs & Financing Options

Origination fee
Discount points
Buydown
Mortgage broker’s fee
Truth in Lending Act
APR
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 option
prepare 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 fee
credit report fee
other preliminary charges

Deposit

Loan Interview

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

Main concerns:
terms of financing contingency
closing date

Contract and closing date

Loan Application Form

First section of form asks about:

type of loan
loan amount
loan term
interest rate

Type and terms of loan

Loan Application Form

Second section asks for:

property address/legal description
purpose of loan (purchase, construction, refinancing)
how buyer will take title
source of downpayment

Property information and purpose

Loan Application Form

Third section asks about applicant(s):

name
social security number
date of birth
years of schooling
marital status
dependents (number, age)

Borrower/co-borrower information

Loan Application Form

Each applicant must also provide:

name and address of employer
number of years at job
position held
type of business

Employment information

Loan Application Form

This section asks about:

primary employment income
overtime, bonuses, or commissions
other sources of income
current rent or mortgage payment

Income and monthly housing expense

Loan Application Form

Assets may include:

good faith deposit
money in bank
investments

Liabilities may include:

car loan
credit cards
alimony/child support

Assets and liabilities

Loan Application Form

Application also asks for information about transaction, including:

purchase price
cost of land
prepaid expenses
closing costs

Details of transaction

Loan Application Form

Applicants must answer questions about:

outstanding judgments, lawsuits
bankruptcies
foreclosures or deeds in lieu
alimony/child support
citizenship

Declarations

Loan Application Form

Applicants also must state:

whether any portion of downpayment
was borrowed
whether property is to be primary residence
any other property owned in last three years

Declarations

Applying for Loan

Federal law requires mortgage brokers and lenders to disclose on loan estimate form:

APR and total interest as a percentage
estimates of all closing costs
whether lender will service loan or transfer servicing

Must also provide booklet with information on closing.

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 disclosures
must 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.

Lock-in is matter of contract between lender and borrower; terms should be in writing.

Locking interest rate

Summary
Applying for Loan

Uniform Residential Loan Application
Good faith estimate of closing costs
Rate lock-in
Float

Application Processing

After application form filled out:

verification forms sent to employers, banks
credit reports, credit scores obtained
if purchase agreement exists:
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.

Underwriting Decision

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

Automated underwriting system usually used.
Loan is either:
approved
rejected
approved subject to conditions

Underwriting Decision

If underwriter approves loan, lender issues letter that commits lender to making loan.

Does impose conditions.
Like a preapproval letter, but more detailed.
Preapproval letter usually issued before borrower finds a property; commitment letter once underwriter has evaluated a particular property.

Commitment letter

Underwriting Decision

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

Buyers may want to:

apply to different lender
apply for different type of loan
wait and take steps to improve finances

Rejection

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 date
disburses purchase price, delivers deed when conditions in purchase agreement are satisfied

Closing agent

Closing Loan

Closing agent may be:

independent escrow agent
employee of lender
title company
lawyer
real estate broker

Closing agent

Closing Loan

Alternatively, parties may meet in person to exchange funds and documents in roundtable closing (“passing papers”).

No funds are held in escrow, and process is coordinated by third party.

Roundtable closing

Closing Loan

Clearing and insuring title
Inspections and repairs
Loan documents issued and signed
Funding loan
Preparing closing disclosure
Recording documents
Disbursing 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 owed
release obtained and recorded

Clearing and insuring title

Steps in Closing Process

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

Usually paid for by buyer.

Clearing and insuring title

Steps in Closing Process

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.

Inspections and repairs

Steps in Closing Process

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

Buyer:

deposits funds required for closing into escrow
signs loan documents

Loan documents and buyer’s funds

Steps in Closing Process

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

Ensures real estate 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

Steps in Closing Process

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

Steps in Closing Process

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, and
any other conditions imposed by lender have been satisfied.

Funding loan

Steps in Closing Process

Closing disclosure form itemizes each party’s charges and credits.

Buyer must receive closing disclosure at least three days before closing.

Closing disclosure

Steps in Closing Process

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

Summary
Application Processing & Closing

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