Lesson 7:

1. Lesson 7: The Financing Process

2. Introduction • In this lesson we will cover the stages of the financing process, including: • shopping for a loan, • applying for a loan, • application processing, and • closing.

3. Shopping for a Loan • For home buyers, shopping for a mortgage loan involves: • assessing wants, needs, and finances; • choosing a lender; • comparing rates and fees; and • evaluating financing options.

4. Shopping for a Loan Assessing the buyers’ circumstances • Buyers should get a realistic idea of what they can afford before they start house hunting. • To establish a price range, they need to find out how much financing they can qualify for.

5. Shopping for a Loan Assessing the buyers’ circumstances • Buyers should get a realistic idea of what they can afford before they start house hunting. • To establish a price range, they need to find out how much financing they can qualify for. • Two ways of doing that: • Prequalifying • Preapproval

6. Assessing Buyers’ Circumstances Prequalifying vs. preapproval • Prequalifying • Informal process that can be done by real estate agent or using online mortgage calculator

7. Assessing Buyers’ Circumstances Prequalifying vs. preapproval • Prequalifying • Informal process that can be done by real estate agent or using online mortgage calculator • Rough estimate of maximum loan amount

8. Assessing Buyers’ Circumstances Prequalifying vs. preapproval • Prequalifying • Informal process that can be done by real estate agent or using online mortgage calculator • Rough estimate of maximum loan amount • Preapproval • Formal process that can be done only by lender (through loan officer or mortgage broker)

9. Assessing Buyers’ Circumstances Prequalifying vs. preapproval • Prequalifying • Informal process that can be done by real estate agent or using online mortgage calculator • Rough estimate of maximum loan amount • Preapproval • Formal process that can be done only by lender (through loan officer or mortgage broker) • Specific maximum loan amount

10. Assessing Buyers’ Circumstances Prequalifying vs. preapproval • For preapproval, buyers must: • complete a loan application, and • provide documentation of income, assets, debts, and credit history.

11. Assessing Buyers’ Circumstances Prequalifying vs. preapproval • For preapproval, buyers must: • complete a loan application, and • provide documentation of income, assets, debts, and credit history. • Lender gives buyers a preapproval letter, agreeing to loan up to a specified amount.

12. Assessing Buyers’ Circumstances Prequalifying vs. preapproval • Advantages of preapproval: • Tool in negotiations with sellers • Streamlines closing process • Preapproval now widely used. • In active market, seller might not even consider offers from buyers who aren’t preapproved.

13. Assessing Buyers’ Circumstances Prequalifying vs. preapproval • Before preapproval became common, prequalifying was standard practice of real estate agents. • Prequalifying is still useful for buyers who aren’t ready to apply for preapproval. • May want to get idea of what’s available and what they can afford. • Knowing how to prequalify a buyer can also help agent understand underwriting process.

14. Assessing Buyers’ Circumstances How to prequalify buyers • Basic steps in prequalifying: • Apply income ratios to monthly income to find maximum monthly payment. • Must cover principal, interest, taxes, and insurance (PITI).

15. Assessing Buyers’ Circumstances How to prequalify buyers • Basic steps in prequalifying: • Apply income ratios to monthly income to find maximum monthly payment. • Must cover principal, interest, taxes, and insurance (PITI). • Subtract percentage (representing property taxes and insurance) from PITI figure to find maximum principal and interest payment.

16. Assessing Buyers’ Circumstances How to prequalify buyers • Use current market interest rate to calculate maximum loan amount based on maximum principal and interest payment.

17. Assessing Buyers’ Circumstances How to prequalify buyers • Use current market interest rate to calculate maximum loan amount based on maximum principal and interest payment. • Divide maximum loan amount by LTV ratio to determine ceiling of price range.

18. Assessing Buyers’ Circumstances Getting preapproved • While prequalifying can be useful, buyers should be encouraged to get preapproved as soon as possible. • Apply to lender or to mortgage broker.

19. Assessing Buyers’ Circumstances Getting preapproved • While prequalifying can be useful, buyers should be encouraged to get preapproved as soon as possible. • Apply to lender or to mortgage broker. • Ask mortgage broker to obtain preapproval letter issued directly by lender. • Preapproval letter issued by mortgage broker doesn’t actually commit lender.

20. Assessing Buyers’ Circumstances Getting preapproved • Preapproval letter valid only for limited period (such as 30 days). • To get preapproval extended, buyers’ information will have to be verified again.

21. Preapproval and Choosing a Lender Prequalifying Preapproval Preapproval letter PITI Loan originator Loan officer Mortgage broker Referral Good faith estimate of costs

22. Loan Costs • Primary consideration for most buyers in choosing lender is how much loan will cost.

23. 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, and • mortgage broker’s fee.

24. Loan Costs Points • Point = percentage point • 1 point = 1% of loan amount

25. Loan Costs Points • Point = percentage point • 1 point = 1% of loan amount • Usage issue: • Some lenders use “points” to refer to origination fee and discount points together. • Others use “points” to refer only to discount points.

26. Loan Costs Loan origination fee • Origination fee pays for lender’s expenses, such as staff compensation, facilities costs, and other overhead. • Charged in almost every mortgage transaction. • Typically around 1% of loan amount. • Paid at closing, usually by borrower.

27. Loan Costs Discount points • Discount points are a lump sum paid at closing to increase lender’s upfront yield (profit) on loan. • In exchange for upfront payment, lender charges borrower lower interest rate. • May save borrower money in long run, depending on how long she owns home.

28. Loan Costs Discount points • How many discount points lenders charge varies depending on market conditions and other factors. • Might charge 4 to 6 points for1% interest rate reduction.

29. Loan Costs Discount points • Example: Market rate for mortgage: 5.25% Lender charges 4 points for 1% rate reduction $300,000 Loan amount x 4% 4 points $12,000 Cost of discount If lender is paid $12,000 up front, will charge borrower only 4.25% interest on loan.

30. Loan Costs Discount points • Discount points may be paid by buyer or seller. • Buydown = Paying lender discount points to “buy down” buyer’s interest rate.

31. Loan Costs Discount points • Discount points may be paid by buyer or seller. • Buydown = Paying lender discount points to “buy down” buyer’s interest rate. • When buyer pays points, pays lender in cash at closing. • When seller pays points, amount is withheld from loan amount and deducted from seller’s proceeds at closing.

32. Loan Costs Miscellaneous fees • In addition to an origination fee and discount points, lenders often charge borrowers other fees, such as: • application fee • document preparation fee • underwriting fee

33. Loan Costs Miscellaneous fees • In addition to an origination fee and discount points, lenders often charge borrowers other fees, such as: • application fee • document preparation fee • underwriting fee • These vary widely from one lender to another. • Borrower should ask loan originator if any can be reduced or waived.

34. Loan Costs Mortgage broker’s compensation • Buyers working with mortgage broker are generally charged amortgage broker’s fee. • May be separate fee or included in points quote for loan.

35. Loan Costs Mortgage broker’s compensation • Buyers working with mortgage broker are generally charged amortgage broker’s fee. • May be separate fee or included in points quote for loan. • Shouldn’t make loan more expensive than one obtained without a broker’s help. • Broker gets loan at wholesale price, marksit up to retail price, keeps overageas fee.

36. Loan Costs Mortgage broker’s compensation • Controversy over another form of mortgage broker compensation: yield spread premium (YSP).

37. Loan Costs Mortgage broker’s compensation • Controversy over another form of mortgage broker compensation: yield spread premium (YSP). • Broker persuades borrower to accept a loan at “above par” (higher-than-market) interest rate.

38. Loan Costs Mortgage broker’s compensation • Controversy over another form of mortgage broker compensation: yield spread premium (YSP). • Broker persuades borrower to accept a loan at “above par” (higher-than-market) interest rate. • Lender pays broker YSP based on difference between market rate and borrower’s rate.

39. Loan Costs Mortgage broker’s compensation • Controversy over another form of mortgage broker compensation: yield spread premium (YSP). • Broker persuades borrower to accept a loan at “above par” (higher-than-market) interest rate. • Lender pays broker YSP based on difference between market rate and borrower’s rate. • Practice gives mortgage brokers incentive to steer borrowers to more expensive loans.

40. Comparing the Cost of Loans Truth in Lending Act • The 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 that requires lenders to disclose the cost of a loan using certain figures and terminology, to make comparison easier.

41. Truth in Lending Act Annual percentage rate • Most important TILA disclosure: annual percentage rate (APR). • APR expresses relationship between all of the financing charges and the amount borrowed as a percentage. • To determine which of two loans is more expensive, compare APRs, not just interest rates.

42. Truth in Lending Act Total finance charge • Another key TILA disclosure: total finance charge. • Total finance charge includes: • interest, • origination fee, • discount points paid by borrower, • mortgage broker’s fee, • finder’s fee, • service fee, and/or • mortgage guaranty or insurance fees.

43. Truth in Lending Act Total finance charge • Total finance charge does NOT include: • title insurance costs, • credit report charges, • appraisal fee, or • discount points paid by seller.

44. Loan Costs No-fee or low-fee loans • Some lenders offer no-fee loansor low-fee loans. • No major lender charges such as origination fee or discount points. • Only (or almost only) financing charge is interest. • Interest rate often much higher than rate for loan with standard fees. • Helpful for buyers with little cash for closing.

45. Loan Costs and Financing Options Origination fee Discount points Buydown Mortgage broker’s fee Truth in Lending Act APR Total finance charge No-fee or low-fee loan Home buyer counseling

46. Applying for a Loan Loan interview • After buyers have chosen a lender, next step is to apply for a loan (or for preapproval). • Loan interview: buyers talk with loan originator • in person, on phone, by fax, or online

47. Applying for a Loan Loan interview • After buyers have chosen a lender, next step is to apply for a loan (or for preapproval). • Loan interview: buyers talk with loan originator • in person, on phone, by fax, or online • Originator helps buyers: • choose best financing option • prepare application

48. Loan Interview Prequalifying during interview • During loan interview, originator may enter information into automated underwriting system. • System provides preliminary evaluation of what buyers are likely to qualify for. • This does not guarantee preapproval.

49. Loan Interview Deposit • Loan originator may require buyers to make a deposit to cover certain expenses. • May include: • application fee, • credit report fee, and • other preliminary charges.

50. Loan Interview Contract and closing date • If buyers have already signed purchase agreement, loan originator reviews contract. • Main concerns: • terms of financing contingency • closing date