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| Home > Resources > Home Buyers' Tutorial > Loan approval process | |
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Home Buyers' Tutorial
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This
document is intended to provide you and your borrowers with a general overview for
obtaining a mortgage loan, how it works, and what important
factors are involved in the process. As it is true with all
investments, the most important factor to a mortgage lender is: how
good of a risk you are as a mortgage applicant.
You are going to borrow a considerable amount of money for a relatively long period of time. Therefore, naturally, the lender is assuming a certain amount of risk by lending you the money. The lender needs to be assured that you will pay back the original loan amount plus the interest on that money. The lender will evaluate all of your documents such as your credit report, your income and debt, etc. and based on that will decide whether or not the risk of extending credit to you falls within their guidelines. If it does, then they will map the risk, to an interest rate. In other word, the better risk you are, the lower the interest rate on your mortgage. There is a wide range of guidelines used by different lenders in approving a loan or matching an interest rate to an applicant. Generally lenders follow a set of guidelines by federal agencies and/or private investors that give them a better chance of selling the loan in the secondary market. Usually the first step is an interview with your relationship manager where you will discuss your options. Loan Officer considers your financial situation such as your assets, liabilities, income, available cash, credit history and the type and price of the propaerty, and will recommend a number of loan options. In other words, the Loan Officer will tell you that you may be qualified for a certain amount of loan for a certain period of time with a certain interest rate. In general, you
need to prepare the following documents for your interview:
You will need to complete the loan application (also known as the form 1003), which is the most important piece of information. Once the lender receives all this information, they will verify them and start the decision making process. The law requires that the lender provides you with an advance disclosure of the Good Faith Estimate of the cost of closing a loan, as well as a Truth-In-Lending disclosing, among other things, the Annual Percentage Rate, also known as the APR. The lender starts
processing the loan after the receipt of your full application.
There are a number of guidelines and criteria they will look
into:
Are you making enough money? Lender will verify your income by mailing your current employer(s) the income verification forms. If a significant amount of your monthly income comes from over time, or bonuses and commissions, lenders want to make sure that it will continue to contribute to your income for a foreseeable future. They will also take into account your employment history and the type of work you do to make sure your job will let you meet your long term obligations. There are also a set of widely used measures called Ratios that can be used to determine your eligibility to obtain a long term credit. There are two type of ratios, Front ratio which is the ratio of your primary housing expenses to your total monthly income and Back ratio, which is the ratio of your total monthly debts (housing, credit cards, car payments, students loans, alimony etc.) to your total monthly income. Each lender uses its own established guide-lines as to what these ratios should be, but, front ratio of 35% and back ratio of 45% are pretty typical examples. This means your total monthly housing expenses should not exceed 35% of your monthly income and your housing expense plus you other long term obligations should not exceed 45% of your total monthly income. As an example, if you make $3000/month and you pay $300/month for your car and you do not have any other obligations, your mortgage payment per month could not be more than $1050. Notice that these
numbers are conservative estimates and each lender uses its own
rules to extend credit to potential borrowers.
How much is your
debt? Your long term
debts, as described above, are important in lender’s decision
making process. Long term debts are defined as debts that are
extended 10 to 12 months into the future. Naturally the more
long term debts you have, the less your capacity to take on
another long term obligation with a fixed income.
Are you credit
worthy? As we mentioned, the approval process, for the large part, deals with the questions of "How good of a long term risk you are". Your credit history is the most important factor that determines the answer to this question. Lenders will obtain a copy of your credit report from each of the three major credit bureaus. This report contains the history of your mortgage and credit card payments indicating any possible 30, 60 or 90 day lates. Any bankruptcy or judgments against you, and your employment history, among other information are also reported. More and more
lenders are using automated systems that assign a number (credit
score) to your credit history.
Can you pay for
the down payment and the other costs associated with the loan? Lenders also require you to pay between 10 to 20 percent of your loan amount in advance, as down payment. However, if you can not make the down payment, you might be qualified with as little as 5 percent (or less depending on your lender and your situation). In these cases, lenders will require you to carry a Private Mortgage Insurance (PMI) to cover for some of the risk they will take. The down payment could come from your savings, IRA, pension plan, life insurance, real estate owned by borrower, stocks and bonds and/or any other source, such as gifts, that is not needed to be paid back. If you plan to
use gifts as the source for your down payment, notice that tax
laws limit the amount of gifts one person can give to another to
$10,000 per year.
Is the house you
are buying worth the money? The property you purchase, is used as a collateral to your loan and acts as a security for your lender. Therefore, your lender requires an independent appraisal report. The appraiser estimates the current value of the property based on the neighborhood, the size of the property, the age of the property, and it’s structural integrity. Lenders would like to make sure that in the case of foreclosure they will be able to recover their investment plus the cost associated with foreclosing on the property.
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