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 buyers' 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 the anxiety by detailing
steps the lender takes in making the loan decision, a 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 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, because 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 address of your bank branch. This will save the lender time
when 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 will usually 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 is 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 an initial approval in about 1 to 2 weeks 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 is to verify your
employment and/or income. This is done by mailing employment and income forms to current
and past employers. 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 a down payment,
usually up to 20 percent of the purchase price for the house. FHA and VA loans require a
down payment (0 to 5 percent) and pay their share of the closing costs (3 percent to 6
percent of the loan amount). If 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 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 over-extending 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.
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