Mortgage Basics-The Four C's of Underwriting
Your Loan Request
Many borrowers find the loan process bewildering and confusing. It doesn't help when those of us who are in the business use verbal shorthand and jargon that separates you from understanding what is going on and what your loan product will do for you.
The creation of your loan, and its approval are variations of four basic moving parts. I learned them as the Four C's: Cash, Credit, Capacity, and Collateral. When lenders design programs and
establish the pricing of the loan (interest rate plus loan fees), they are assessing the layers of risk associated with each of these categories.
Let's take a look at each of them.
Cash: The lender wants to know that you have enough money to provide for your down payment for the purchase of the home, that you can pay for your closing costs, and that have some level of cash reserves after the closing. They also want to know the source of those funds, so if money suddenly appears in your accounts just before closing they will be concerned that the new money is also borrowed. If you are refinancing, they will want to see that your closing costs and reserves are covered.
Credit: Until the advent and acceptance of credit scoring, the lender would review the credit report and make an assessment as to the paying habits, the types of credit the borrower had (mortgage, auto loans, credit cards, student loans, finance companies, charge-offs, collections), and whether they were prudent users or abusers of credit. It was a combination of objective and subjective analysis, and was more art than science.
The credit scoring systems now take all of these factors into account in a "black box" analysis and produce a score. Because each of the three credit repositories use proprietary systems, they don't publish exactly how their scores are produced. http://www.myfico.com/ is one site that will allow you to subscribe and do "what if?" scenarios if you are interested in pursuing a program to improve your credit score.
Capacity: This refers to your ability to pay the monthly payments. The two primary areas of interest are employment stability and that your income is sufficient to support the proposed new mortgage debt, taxes and insurance, homeowner's association fees, and all your consumer credit obligations. As a general rule, lenders are looking for continuous employment in the same job or line of work of at least two years. Also, they like to see that the sum of those monthly obligations listed above fit within about 40% of your gross monthly income if you are salaried or a wage-earner.
If you are self-employed or earn commissions the lenders will do their analysis based on your gross income less business expenses. This calculation gives them an idea of what your personal income is, and it puts you on an equal footing with the salaried person and wage-earner.
Collateral: A real estate loan is secured by a piece of property. The lender ultimately wants to have their loan secured so that if you don't make your payments, they have the ability to recover the unpaid balance of the loan through a foreclosure proceeding. This is why the lenders require an appraisal of the home, so that they can feel comfortable that their loan is well-secured. Lending guidelines change and risk assessments differ when the property is owner-occupied or a rental, if it is a detached home, a condominium, or if it is in a planned-unit development.
When you add in the variables of documenting the loan fully with paystubs, W-2 forms and tax returns, or if you are requesting a loan using the "stated income" option, where the lender makes their decision based on the reasonableness of the income presented without verifying it, or if you are pursuing a 'no-doc' loan, where the lender is making their judgment solely on the appraisal and credit history and scores, you can see that there are a myriad of possibilities and categories for a loan request to fit within.
When you are shopping for a mortgage, and the representative gives you a quote without exploring these variables with you, the information you are receiving is meaningless. Know with whom you are working and that they are taking care to provide you with accurate information so that you are not encouraged to begin the process with false expectations and to be presented with the real terms at a later date.
Wednesday, May 23, 2007
Wednesday, May 9, 2007
Approvals Are Getting Tougher
Plan Ahead For Your Mortgage Needs-
Lenders are Tightening Up on Approvals
You have probably been aware over the last few months that many lenders who specialized in the sub-prime lending markets (loans made to borrowers or on properties that present more risk to the lender, also known as "B" and "C" lending) experienced sizable losses and were forced to close their doors.
Many times, these sub-prime lending operations were owned by larger financial companies, and the losses rippled through to the more profitable lending operations. Whenever lenders go through this part of the business cycle, they analyze what contributed to the losses and seek to make corrections.
As such, the lenders that are continuing in the sub-prime markets are restricting the scope of the lending programs from what they were even three to six months ago. They seek to limit their risk by not granting loans to as large a percentage of the value of the home as they did before. For example, where they would make a loan to 100% of value, they are not limiting the loan to no higher than 95% of value.
They can also limit their risk by requiring higher credit scores than they used to. It has not been uncommon to see programs that used to require a score as low as 620 now have a higher threshold at 640 or 660.
The underwriting guidelines have also been tightened in some cases by requiring more in the way of cash reserves after closing than they previously required. In the past, some programs wanted to see that the borrower had 2 months of mortgage payments in their bank accounts at the conclusion of the transaction. Now we are seeing requirements up to 6 months of mortgage payments.
In some cases, the lenders combine these changes to really restrict their risk. Whereas six months ago, we may have been able to get 100% financing with a 620 credit score and 2 months of mortgage payment reserves, the conservative lender may limit the loan to 95%, demand a score of 660, and require cash reserves of 4 months of mortgage payments.
As you can see, this would put a borrower who purchased under the more liberal terms a year or so ago, who was planning on refinancing into more favorable interest rates or payments, in a serious bind. The exit strategy that they had carefully crafted was removed by the changes in the guidelines as a result of the losses that the lenders had experienced.
Even though these examples were primarily dealing with the sub-prime lenders, the fact is that the prime lenders ("A" lending) also are going through tightening so that they don't start experiencing losses in the same way that the sub-prime lenders did.
The ways that "A" lenders have been attempting to reduce their risk include the increase of the minimum credit score threshold, and not being as aggressive on the percentage of loan in relation to the value of the home.
On refinances, they are also limiting the amount of cash that a borrower can receive through the transaction, and being less generous on loans on investment properties and condominiums. These categories - cash out, investment properties, and condominiums - all represent additional layers of risk to a lender and they are doing their best not to accept a lot of exposure to these risks.
The important point that I want to impart to you with this edition of my newsletter is that you should not think that everything is business as usual. Many times borrowers will wait until the last minute thinking that there have not been any changes, and that the application process will go as smoothly as it has in the past, or that the loan programs will continue without limits to their availability.
If you, or someone you know, has a loan that is scheduled for an interest rate or payment reset soon, let's have a conversation right away to make sure that we can do the best possible job of getting things taken care of.
This is truly one of those times that it is better to act sooner than later.
Lenders are Tightening Up on Approvals
You have probably been aware over the last few months that many lenders who specialized in the sub-prime lending markets (loans made to borrowers or on properties that present more risk to the lender, also known as "B" and "C" lending) experienced sizable losses and were forced to close their doors.
Many times, these sub-prime lending operations were owned by larger financial companies, and the losses rippled through to the more profitable lending operations. Whenever lenders go through this part of the business cycle, they analyze what contributed to the losses and seek to make corrections.
As such, the lenders that are continuing in the sub-prime markets are restricting the scope of the lending programs from what they were even three to six months ago. They seek to limit their risk by not granting loans to as large a percentage of the value of the home as they did before. For example, where they would make a loan to 100% of value, they are not limiting the loan to no higher than 95% of value.
They can also limit their risk by requiring higher credit scores than they used to. It has not been uncommon to see programs that used to require a score as low as 620 now have a higher threshold at 640 or 660.
The underwriting guidelines have also been tightened in some cases by requiring more in the way of cash reserves after closing than they previously required. In the past, some programs wanted to see that the borrower had 2 months of mortgage payments in their bank accounts at the conclusion of the transaction. Now we are seeing requirements up to 6 months of mortgage payments.
In some cases, the lenders combine these changes to really restrict their risk. Whereas six months ago, we may have been able to get 100% financing with a 620 credit score and 2 months of mortgage payment reserves, the conservative lender may limit the loan to 95%, demand a score of 660, and require cash reserves of 4 months of mortgage payments.
As you can see, this would put a borrower who purchased under the more liberal terms a year or so ago, who was planning on refinancing into more favorable interest rates or payments, in a serious bind. The exit strategy that they had carefully crafted was removed by the changes in the guidelines as a result of the losses that the lenders had experienced.
Even though these examples were primarily dealing with the sub-prime lenders, the fact is that the prime lenders ("A" lending) also are going through tightening so that they don't start experiencing losses in the same way that the sub-prime lenders did.
The ways that "A" lenders have been attempting to reduce their risk include the increase of the minimum credit score threshold, and not being as aggressive on the percentage of loan in relation to the value of the home.
On refinances, they are also limiting the amount of cash that a borrower can receive through the transaction, and being less generous on loans on investment properties and condominiums. These categories - cash out, investment properties, and condominiums - all represent additional layers of risk to a lender and they are doing their best not to accept a lot of exposure to these risks.
The important point that I want to impart to you with this edition of my newsletter is that you should not think that everything is business as usual. Many times borrowers will wait until the last minute thinking that there have not been any changes, and that the application process will go as smoothly as it has in the past, or that the loan programs will continue without limits to their availability.
If you, or someone you know, has a loan that is scheduled for an interest rate or payment reset soon, let's have a conversation right away to make sure that we can do the best possible job of getting things taken care of.
This is truly one of those times that it is better to act sooner than later.
Subscribe to:
Posts (Atom)