What Happens After You
Apply For A Mortgage?
Scientists who study
and measure human behavior find that buying a home is one of the most
stressful experiences of our lives. Contributing significantly to this
anxiety is waiting for the mortgage to be approved. Much of the home-buyer's
unease results from not knowing what is going on. You know credit checks
and verifications of employment are taking place-but what makes the difference
between getting or not getting that loan, and how long does it take? This
page can dispel at least some of that anxiety by detailing the steps the
lender takes in making the loan decision-process called "underwriting."
Listed below are the topics addressed on this page.
Just as wise stock
market investors carefully research the companies in which they plan to
buy stock, careful mortgage lenders investigate the financial background
of each loan applicant. In lending the prospective home-buyer the money
to buy the home, the lender assumes a long-term risk. The assumption is
that the borrower is going to eventually repay the loan and in the meantime
make the loan payments on time.
Once all the information
is collected and eligibility is established, the lender decides whether
to extend the home-buyer credit. In other words, lenders analyze the risk
of lending (making the investment), and match it to an appropriate interest
rate and loan term.
There are no established,
industry-wide standards for underwriting, though most lenders follow standards
set by government-related agencies, private mortgage insurers, private
mortgage investors or institutional investors. The vast majority of mortgage
lenders attempt to approve a loan application if at all prudently possible,
but to approve a loan that will become delinquent serves no one's best
interest. The burden falls on the lender to establish that an applicant
is qualified.
The process usually
begins with an interview where the prospective borrowers and a representative
of the lender sit down to discuss the potential loan. Increasingly, however,
lenders are not requiring a face-to-face meeting and accept a completed
application by mail. Many lenders today will even qualify you for a loan
before you begin to shop for a home. Many lenders advertise this service
in the local newspaper, but any lender can provide it. Knowing approximately
how much money you are qualified to borrow can save you time and prevent
disappointment when you are looking at houses.
When going to see
a lender for an initial interview, you should take:
- Purchase contract
for the house if you have one.
- Certificate of
Eligibility from the Veterans Administration (VA) if you want a VA loan.
(Note: If you do not have one, the lender will obtain the information
for you from your service records.
- Bank account numbers
and the address of your bank branch. This will save the lender time
in checking your credit.
- Credit card bills
for the past several billing periods.
- Pay stubs, W2
forms or other proof of employment and salary.
- If you are self-employed,
you should be able to present balance sheets, tax returns and other
information about your business.
The important document
that gets the whole process rolling is the loan application. It asks in-depth
questions concerning you, your income, assets and liabilities, your credit,
and your legal history, as well as a description of the property you wish
to buy. The lender will verify the information you provide on the application
before making the decision whether to extend the loan.
Applicants usually
will know after the initial interview if they are qualified for the type
and size of loan they want. Lenders try to let the borrower know as quickly
as possible if they really are not qualified for the size of loan that
they request.
The initial interview
sets in motion some important consumer safeguards. The Truth-in-Lending
disclosure requirements provide the applicant with an estimated yearly
cost for the loan - the Annual Percentage Rate (APR). The other
important disclosure that follows from the Real Estate Settlement Procedures
Act (RESPA), a federal law. This requires lenders to provide home-buyers with information on known and estimated closing costs.
The initial interview
also starts a clock that will allow applicants to know whether or not
they have been approved in about 30 to 60 days from the submission of
a completed application. If the loan is denied, the lender must disclose
the specific reason (s) for the rejection.
Following the initial
interview, or loan application, the first step the lender takes is to
verify your employment or income. This is done by mailing employment and
income forms to current and past employers, and it will help the lender
determine how much debt you can successfully take on.
A general rule is
that you can qualify for a loan of up to twice the family's income (i.e.
a family with income of $30,000 a year usually can qualify for a mortgage
of up to $60,000). Often, the amount you earn may not be as important
as how you earn it. Bonuses and commissions can vary greatly from year
to year, and lenders are reluctant to depend on them if they make up a
large percentage of your income. There are similar problems when a large
portion of your salary is based on overtime pay, and you rely on it to
qualify for the loan. In the case of bonuses and commissions, the lender
will want to verify your bonus and commission status back two or three
years to get a better idea of what you earn from those sources on average.
In the case of overtime, the lender will establish whether the work is
expected to continue and whether or not the amount of overtime income
is reasonable for the extra work. After establishing these points, the
mortgage lender will make a decision as to how much to allow for these
additional sources of income.
If you are self-employed,
you should plan on producing a balance sheet, profit and loss statements
and copies of your federal income tax returns for the past two or three
years. Tax returns may also be required to verify other income claims,
such as when income from securities is a major source for mortgage payments.
Lenders use a set
of general standards (income/expense ratios which show how much income
is used for various expenses) to test the application for qualification.
These standards are based on what experience shows a homeowner can spend
to own the home and also take care of other long-term financial obligations,
though lenders use their own discretion in making the final decision.
Lenders generally
say that housing expenses (including mortgage payments, insurance, taxes
and special assessments) should not exceed 25 percent to 28 percent of
the homeowner's gross monthly income. For Federal Housing Administration
(FHA) loans, this figure is not to exceed 29 percent of the home-buyer's
gross monthly income. With loans guaranteed by the Department of Veteran's
Affairs (VA), lenders measure prospective home-buyers with Residual
Income, or the monthly income minus expenses. The remainder is then
measured against geographical and family size data to qualify the borrower.
Your lender will
work out these figures for you when you sit down to discuss the mortgage
you want.
- FHA Loans
- Housing Expenses
= 29% gross monthly income
- Housing Expenses
plus Long-term Debt = 41% gross monthly income
Lenders usually define
long-term debt as monthly expenses extending more than 10 months into
the future. These expenses should not exceed 33 percent to 36 percent
of the homeowner's gross monthly income. FHA-insured mortgage lenders
define long-term debt as monthly expenses extending 12 months or more
into the future, and look for these expenses plus housing expenses not
to exceed 41 percent of the homeowner's gross monthly income.
Before extending
credit, lenders will want to examine the risk of not getting the money
back. To do this lenders will look at four crucial aspects of your credit
history when you apply for a mortgage:
- History of
past credit - what were the size and terms of past loans?
- Type of Credit
- have you obtained real estate, auto, personal or other installment
loans in the past?
- Attitude toward
credit - are active accounts current , and is there any recent bankruptcy
or judgment?
- Lapses in employment
or debt repayment - how many unexplained lapses are there, and for
how long?
From the information
uncovered by these four questions, lenders can develop a fair idea of
just how you will handle your responsibilities once you have signed the
contract for repaying the loan. However, lenders cannot examine everything
when putting together a credit history. They have two extremely important
limitations on credit information gathering.
The first limitation
is the Fair Credit Reporting Act, which was designed to ensure fair and
accurate consumer credit reporting. The Fair Credit Reporting Act stipulates
that lenders must certify the purpose for which the information is sought
and use it for no other purpose. The Act also prohibits reports based
on subjective information from neighbors and others concerning character,
general reputation and other personal aspects. Certain other credit information,
such as bankruptcy more than seven years before, is also prohibited unless
the principal involved in the action was $50,000 or more.
The second consumer
safeguard limiting the credit information lenders can use to make a mortgage
decision is the Equal Credit Opportunity Act (ECOA). ECOA prohibits
discrimination in lending based on race, color, national origin, sex,
marital status, age (provided the applicant may legally contract), and
the fact that all or part of the applicant's income comes from a public
assistance program.
Lender's are also
prohibited by law from asking:
- questions concerning
the applicant's spouse, unless
- the spouse
will be contractually liable,
- the spouse's
income will be used to qualify,
- the applicants
live in a community property state, or
- the applicant
will use child support, alimony or separate maintenance payments
from a spouse or former spouse to qualify.
- questions concerning
future parenting plans (although the lender may ask the ages and
current number of children the applicant has).
Lenders expect home-buyers to have enough money available to make the down payment of between
10 and 20 percent of the asking price for the house-though FHA and VA
loans require smaller down payment (0 to 5 percent) and to pay their share
of the closing costs (3 percent to 6 percent of the loan amount). If,
however, you cannot come up with a 20 percent down payment, a lender can
make you a loan for as little as 5 percent down. He will, however, require
you to carry private mortgage insurance for conventional (not FHA or VA
loans), for which you will pay a premium for the first year and an additional
monthly fee in subsequent years.
Sources on which
prospective home-buyers may draw for the down payment and the closing
costs include savings, stocks/bonds, Individual Retirement Accounts (IRAs),
pension funds, real state holdings, life insurance policies, mutual funds
or employee savings plans.
Home-buyers may also
rely on another source of funding for the down payment-a gift, or money
given by a parent or other relative that need not be repaid. a person
may give another person up to $10,000 per year without either party being
taxed. A married couple, therefore, could give a child or spouse as much
as $40,000 for a down payment tax-free. Remember, however, that if you
use gift money for a down payment, you will need to present a letter so
stating and signed by both the giver(s) and the receiver( s) to your lender.
Mortgage lenders
send a form to the home-buyer's savings institution(s) to verify the amount
available for purchasing the house, as well as the amount of outstanding
loans with that institution.
Mortgage lenders
also examine the real estate being purchased to make sure that, in case
of foreclosure, the lender has a salable property. The property's acceptability
is established by an independent appraisal.
The appraiser looks
not only at what the home is worth today, but how the neighborhood's dynamics
will affect the property value in the future. The three main points the
appraiser checks are:
- Physical security
of the property.
- Age, structural
soundness, landscaping, etc.
- Location.
- The kind of
neighborhood, surrounding houses, access to transportation, commercial
development nearby, etc.
- Local government's
plans for the area.
- How zoning
and taxes will affect the property in the years to come.
Your lender has made
all the checks. Your income, credit, assets, property and all necessary
documentation have been scrutinized. Now comes the big decision.
If the lender's decision
is to extend the credit, you will be notified, usually through a commitment
letter. The mortgage lender can approve the home-buyer for the entire
amount asked for, or a lesser amount based on the borrower's qualifications.
The commitment terms relating to interest rate and/or discount points
may be firm at the time of commitment or conditioned on the market rate
at the time of closing. If the decision is not to extend the credit, the
lender has 30 days from the acceptance of the completed application to
notify the prospective home-buyer This notification must also include
the reason(s) for the rejection.
If the loan is eligible
for government insurance or guaranty, written agreements stating so are
issued. These can be either an FHA or Firm Commitment or VA Certificate
of Commitment. Conventional loans (not FHA or VA) receive an application
for private mortgage insurance if the down payment is less than 20 percent
of the purchase price.
By now you should
feel a bit more at ease about what happens after you apply for a mortgage.
If you have a good credit rating, it will speak for itself. Also, it is
up to the lender to prevent home-buyers from overextending themselves
to the point of losing their homes. Prudent underwriters should prevent
this from occurring.
Certainly there will
always be some anxiety associated with applying for a mortgage, but if
you understand the process, waiting for approval will be far less worrisome.
|
