Chapter 13

1. Chapter 13 Qualifying the Borrower REAL ESTATE FINANCE PRESENTATION 8

2. Qualifying the Borrower Before agreeing to make a real estate loan, a lender will evaluate both the borrower’s ability and willingness to repay the loan, and whether or not the property is of sufficient value to serve as collateral for the loan. This evaluation process is called LOAN UNDERWRITING. TQ The individual who conducts this process is called an UNDERWRITER. TQ The primary concern of the underwriter is to minimize the amount of the lender’s risk.

3. I. FHLMC/FNMA Underwriting Standards

4. Freddie Mac/Fannie Mae Underwriting Standards According to the Freddie Mac: “underwriting mortgage loans is an art, not a science. It cannot be reduced to mathematical formulas, but requires sensitive weighing of the many aspects of the loan.” TQ There are many factors related to the borrower’s loan application that an underwriter will consider; they will all relate to income, net worth, and credit history.

5. A. INCOME Conventional lenders consider a borrower’s income adequate for a loan if the proposed payment of principal, interest, taxes, and insurance does not exceed 28% of his or her stable monthly income. STABLE MONTHLY INCOME TQ DEBT SERVICE = DEBT TO INCOME TQ

6. DEBT RATIOS MADE TO EXCEED? • 28/31 means i.e., min down max LTV • 20% Down Payment • 80% Loan To Value • What about more down??? • 40% Down Payment • 60% LTV • 50% Down / 50% LTV • DTI RATIO CAN BE EXCEEDED UP TO 55% TQ

7. WHAT??? • YOU heard right • Why can rules be broken? • Risk Factor is decreased • Really? You gonna’ put 50% down • You probably have even more reserves • You probably have super FICO score • You DEFININTELY don’t want to lose investment!!

8. What about higher FICO? • Better credit scores mean higher DTI probably • A little better probably a little higher • A lot better, a bit more higher probably • Still more $$ is a better risk factor • Credit scores can go up and down • $$$ Talks NOTE: THIS IS LIKELY, NOT GUARANTEED!!!

9. 1. Stable Monthly Income As mentioned earlier, stable monthly income is the base income of the borrower, plus earnings from acceptable secondary sources. Before concluding there is a sufficient quantity of income, the underwriter must decide what portion of the total verified earnings are acceptable as a part of his or her stable monthly income. IT’S ALL FULL DOC!!!!! TQ Quality Durability Bonuses, Commissions, and Part-Time Earnings Overtime Unemployment (if regular) and AFDC Alimony, Child Support, or Maintenance Income from Other Family Members Self-Employment Income Co-mortgagor Rental Income Verifying Income

10. FULL DOC – WAS’ DAT? • It means all income and assets and everything else will be backed up with: TQ • Bank statements • Paystubs, W-2’s, 1099’s, 1040’s, etc. • Audited P & L & Bal. Sheet (Year To Date) • Divorce settlements (for $$) • Appraisals • Rent Surveys • You name it!

11. 2. Computing Monthly Earnings When converting hourly wages to monthly earnings, multiply the hourly wage by 40 (hours in a work week), then multiply by 52 (weeks in a year) and divide by 12 (months in a year) Monthly=HOURLY X 40 X 4.333 or YEARLY / 12 Example: Hourly Wage: $20.00 x 40 x 4.333 = 3466.67 Weekly Income: $20.00 x 40 = $800 Annual Income: $800 x 52 = $41,600 Monthly Income: $41,600 ÷ 12 = $3,466.67

12. 3. Employment History When evaluating the elements of a borrower’s income (quantity, quality, and durability), the underwriter will analyze the individual’s employment stability using the Request for Verification of Employment, and/or Paystubs for 30 days TQ Annual income for 2 years, i.e., 2 years 1040’s A borrower with a history of steady, full employment will be given more favorable consideration than one who has changed employers frequently, unless the changes are properly explained. As a general rule, a borrower should have continuous employment for at least two years in the same field.

13. 4. Advancement If the borrower has changed employers for the sake of advancement within the same line of work, the underwriter will likely view the change favorably. TQ On the other hand, persistent job hopping without advancement usually signifies a problem of some kind and an underwriter will tend to regard the individual’s earnings as unstable. TQ

14. 5. Education and Training Special education or training that prepares an individual for a specific kind of work can strengthen a loan application. Such education or training can offset minor weaknesses with respect to earnings or job tenure if the underwriter is convinced there is a continuing demand for individuals in this line of work.

15. B. NET WORTH According to Fannie Mae, “accumulation of net worth is a strong indication of credit worthiness.” TQ A borrower who has built up a significant net worth from earnings, savings, and other investment activities clearly has the ability to manage financial affairs and accumulate wealth. An individual’s NET WORTH is determined by subtracting personal liabilities from total assets.

16. 1. Required Reserves After Closing As a safeguard against unexpected bills or temporary loss of income, and as a general indicator of financial ability, Fannie Mae requires the borrower to have sufficient cash on deposit, or in the form of highly liquid assets, to cover two months’ payments (PITIM) after making the down payment and paying all closing costs. AUTOMATED U/W (DU-Desktop Underwriter) findings will be the guideline ultimately. TQ FHLMC guidelines require a minimum of two months’ payments for all owner-occupant loans, without regard to loan-to-value ratio, and three to six months for non-owner-occupant loans.

17. INVESTMENT PROPERTYRESERVES • Investment Property = Non Owner Occ. • 6 months reserves for rental TQ • And for each rental with a loan on it • Yep 3 rentals = 18 months reserves • 2 months reserves for residence & any 2nd home (owner occupied – vacation home)

18. 2. Verification of Assets Included in every loan application is a section devoted to assets. TQ The underwriter will take whatever steps are necessary to verify the nature and value of assets held by the borrower. LIQUID ASSETS NON-LIQUID ASSETS

19. 3. Verification of Deposit The underwriter will use the Request for Verification of Deposit form to prove the borrower has the necessary funds in his or her bank account(s). This form is sent directly to the bank and returned to the underwriter without passing through the borrower’s hands. Used less often now, than bank statements TQ

20. 4. (Previously) Alternative, now the Usual Verification Method TQ Lenders may use an alternative method of verifying deposits: the borrower may submit the original bank statements for the previous two months to verify sufficient cash for closing. 2 months per account being verified

21. 5. Financial StatementSelf Employed or Multiple Incomes If a borrower’s assets are substantial and diverse, an audited financial statement may be the best way to explain the borrower’s creditworthiness to the underwriter. A FINANCIAL STATEMENT is a summary of facts showing the individual’s financial condition; it contains an itemized list of assets and liabilities which serves to disclose net worth.

22. 6. Real Estate for Sale If a borrower is selling a property to raise cash to buy the subject property, the equity may be counted as a legitimate asset, SUBJECT TO closing that sale! EQUITY is the difference between the market value of the property and the sum of the selling expenses, mortgages and other liens against the property. TQ Equity is what the buyer should receive from the sale of the property.

23. 7. Other Assets Any assets held by the borrower will help the loan application. Assets, other than cash and real estate, typically listed in a loan application include automobiles, furniture, jewelry, stocks and bonds, and cash value in a life insurance policy OR retirement fund.

24. 8. Gift Letter If an applicant lacks the necessary funds to close a transaction, a gift of the required amount from relatives is usually acceptable to the underwriter. The gift WILL be confirmed by means of a (gift) letter signed by the donor. The letter should clearly state that the money represents a gift and does not have to be repaid. There is a form for this!! Also, evidence of donor’s ability to give will be required!! TQ

25. C. CREDIT HISTORY As a part of the loan evaluation, the underwriter will analyze the credit history of the borrower; this is accomplished by obtaining a credit report from a responsible credit rating bureau. A high FICO credit score is the standard by which a borrower’s creditworthiness is determined. TQ Here are some helpful hints to increase your credit score: 1. Pay bills on time. 2. Limit outstanding debt. 3. Have a long credit history. 4. Restrict your credit. 5. Too much credit.

26. Figure 13-7

27. 1. Explaining Derogatory Credit LESS IMPORTANT NOW THAN EVER DUE TO FICO’s TQ Most people try to meet their credit obligations on time; when they do not, there is usually a reason. A loss of job, hospitalization, illness, death in the family or even divorce can create extraordinary financial pressures and adversely affect a credit report. It may be possible to successfully explain the ratings if the borrower can show that the problems occurred during a specific period of time for an understandable reason, and that prior and subsequent credit ratings have been good.

28. 2. Bill Consolidation, Refinancing Even in the absence of derogatory ratings, there are matters that can be revealed by a credit report which might indicate the borrower is a marginal credit risk. If an individual’s credit pattern is one of continually increasing liabilities and periodically “bailing out” through refinancing and debt consolidation, he or she may be classified as a marginal risk. The pattern suggests a tendency to live beyond a prudent level.

29. 3. Illegal Discrimination A borrower must be of legal age (18) before he or she can qualify for a loan; after that, an applicant’s age is not a valid reason for rejecting a loan. NO MATTER HOW OLD WE ARE!!! TQ Your life expectancy is NOT a factor!!!!! In addition to age, a lender cannot use as a basis for denying a loan the race, color, creed, national origin, religion, handicap, familialstatus, marital status, or sex of the borrower. TQ TQ TQ

30. Figure 13-8

31. Qualifying a borrower Summary The loan underwriting process evaluates both the property and the borrower’s willingness and ability to pay off the loan. An underwriter will make a determination of these factors by analyzing the borrower’s current income, debt levels, overall net worth, and credit history. For conventional loans, these will be the guidelines of FNMA (FANNIE MAE) and FHLMC (FREDDIE MAC).

32. Chapter 14 Qualifying the Property Valuation Broker Price Opinion Appraisal

33. I. The Lender’s Perception of Value APPRAISAL

34. Lender’s Perception of Value Lenders utilize Licensed and Certified Appraisers to provide a professional opinion of market value for each residence they loan upon. By both state and federal law appraisers are required to provide an unbiased and independent analysis of the property. TQ MARKET VALUE is the price paid by a typical buyer; it is based on the analysis of a group of actual sales that occurred in the marketplace. It is this true market value that a lender seeks, because if a foreclosure is ever necessary, the lender has some assurance that the property can be sold for an amount that can enable them to recover most, if not all, of their investment.

35. A. LTV AND MAXIMUM LOAN AMOUNT Loans are generally made at a loan-to-value ratio of from 80% to 90% of the value of the property. Example: $180,000.00 Sales Price $150,000.00 Appraised Value $150,000.00 Appraised Value x .80 Loan to Value Ratio $120,000.00 Maximum Loan In the example, the maximum loan is predicated on the lower appraised value, not the higher sales price. If the lender were to base the loan on the higher of the two figures, it would be loaning an amount that would be 96% of the appraised market value.

36. B. ESTIMATING MARKET VALUE It is not necessary for agents and loan officers to be able to appraise properties, BUT it is NECESSARY TO DO A VALUATION!! TQ However, it is helpful to understand the mechanics of the appraisal process and to know something about the reasoning and logic that underlies many of the appraiser’s conclusions. For real estate agents, an understanding of how lenders and their appraisers perceive value will enable them to write and arrange financing for sales that will hold together.

37. II. Market Approach This is the only way value is determined. Yes, appraisals have “replacement value” or “cost of construction” BUT the value that is used is MARKET VALUE! TQ

38. Market Approach The market approach to value is the most easily understood by the layman. The MARKET APPROACH involves a comparison of the property being appraised against other similar properties in the same neighborhood that have recently sold or are currently being offered for sale AKA “COMPS”. TQ Appraisers know that no informed buyer who is acting free of pressure will pay more for a particular property than he or she would have to pay for an equally desirable substitute property. An informed seller is not likely to sell for less than is necessary, and if he or she is objective, the selling price will be based on the results of recent sales in the neighborhood. The property sales that appraisers actually use are those that have closed escrow.

39. A. IDENTIFYING LEGITIMATE COMPARABLES When utilizing the market approach, the appraiser must be certain that the sales used as a basis for comparison are, in fact, relevant in terms of the factors that have the most impact on value

40. 1. Metropolitan Statistical Areas A METROPOLITAN STATISTICAL AREA is an area with a core city population of 50,000 people and the area surrounding it. The information obtained from these areas is considered to be significant to business, industry and consumer groups. Bar graphs may be combined with a frequency curve to provide what is known as a HISTOGRAM. FREQUENCY CURVES BELL CURVE

42. 2. Multiple Regression Analysis Another tool consists of the use of MULTIPLE REGRESSION ANALYSIS, which is a statistical procedure that attempts to assess the relationship between a dependent variable and two or more independent variables. THIS IS ALSO KNOW AS “FANCY B.S.”

43. 3. Automated Valuation Models Currently, NOT a popular tool for the selection of comparable sales, the AUTOMATED VALUATION MODEL (AVM), which is a computer generated valuation report, THAT WAS the darling of the lending industry FOR 5 MINUTES! TQ Many residential lenders accept AVM reports in lieu of traditional appraisals for both first and second mortgages. An AVM can review and select from hundreds of properties within seconds. If the AVM is combined with a regression analysis program it can provide a bottom line value in seconds.

44. AVMs (cont.) Well, it turns out that most AVMs are only accurate about 65% of the time. All economic and appraisal modeling programs require proper calibration by the user. In addition, the raw data put into many models is often unverified and incorrect. For example, most county data is anywhere from 10-15 years old and may not include homeowner upgrade information. The AVM program assumes that every residence in your area is of the same quality and condition. The question might be asked: “Why do we need an appraiser?”

45. 4. Appraiser Assisted AVMs To try to answer these problems the industry has developed the APPRAISER ASSISTED AUTOMATED VALUATION MODEL (AAAVM). These programs are modified to allow an appraiser to manually input information, make some adjustments, and do minimal calibration. Also, the appraiser signs off on the result which takes care of who is liable for the accuracy of the AVM. NOT A TQ ISSUE!!!! NOT TQ…….

46. 5. Sale Date of the Comparable Sale The sale should be recent—within the past six months, if possible. Recent sales are used because they most accurately reflect what is occurring in the current market and do not require adjustments for time.

47. BROKER PRICE OPINIONS • “Cheap” appraisals that lenders order from us brokers who want to make $20 an hour (or less) on average. TQ • Use comps 3 mos or less old, within 1 to 3 miles (depending on rural, urban, or suburban…which is flexible), within 20 to 25% of the GLA (gross living space) and a reasonable variation of lot size, and age construction (year built) TQ

48. BROKER VALUATION • Generally do your own “BPO” (you just don’t get paid for it until the listing sells • Used to estimate value of a listing • Follow same guidelines • Aka “Comparative Market Analysis” • All of the above are TQ issues.

49. 6. Location of the Comparable Sale Comparables should be selected from the neighborhood of the subject property. In the absence of any legitimate comparable sales in the neighborhood, the appraiser can select comparables from nearby similar neighborhoods. TQ Care must be taken that the properties and the neighborhoods have similar physical and demographic characteristics.

50. 7. Physical Characteristics To qualify as a comparable, a property should have physical characteristics that are essentially similar to the subject property. TQ That is, for example, compare two story homes to two story homes…dome homes t dome homes (oops, this is known as a “non-conforming construction”)…seen many of them around? TQ