Evaluating Mortgage Loan Programs

 The residential lending process can be confusing for consumers and beginning real estate agents

By Jeff Sorg, OnlineEd Blog

(August 26, 2020)

 OnlineEd – The residential lending process can be confusing for consumers and beginning real estate agents. While most real estate agents will send their clients to a mortgage broker for the qualifying process, it is still important for the new agent to gain an understanding of some key loan terminology to be better able to their help clients understand which loan program might be best for their particular financial situation, and which offers the best savings over the loan term.

These are some key features to understand when your client is evaluating different loan programs:

    1. Loan origination fees – These are fees charged by a lender to cover the administrative costs of processing a loan. The origination fee is expressed in terms of points, with one point being 1% of the loan amount.
    2. Discount points – Discount points lower the monthly loan payment by collecting a lump sum payment of interest upfront at transaction closing. This lump sum payment will fund the loan at a lower interest rate for the entire term of the loan. The number of discount points charged by the lender will correspond with the market interest rate as compared with the consumer’s requested interest rate. The lower the underlying interest rate in contrast to the market rate, the more discount points will be charged. One discount point is 1% of the loan amount.
    3. Buydowns – A buydown is also interest paid to the lender upfront in a lump sum. In exchange for this payment, the lender agrees to lower the interest rate, which, in turn, reduces the monthly payment for a specified period. Buydowns serve the same function as discount points. However, they do not always work in the same way. For a conventional loan, it does not matter who pays the buydown. Additionally, buydowns can be used with both fixed-rate and adjustable-rate loans, and they can be either temporary or permanent. Temporary buydowns are the most common and apply for the first year or first few years of the loan. Buydowns can be paid by the buyer or the seller and are commonly used when the borrower cannot qualify because the payments are too high. The temporary buydown allows the buyer to be eligible for the loan on the initial lower payment with the buydown applicable for the first one, two, or three years. A permanent buydown allows a borrower to finance up to 3 discount points into the loan amount.
  1. Truth in Lending (Regulation Z) – The purpose of the Truth in Lending Act, implemented by Regulation Z, is to compel lenders to disclose loan terms to prospective borrowers for comparison purposes. All residential loans, except seller financing, are covered under Truth in Lending. All loan fees, loan terms, and the APR (Annual Percentage Rate) must be disclosed. The APR is the actual annual percentage rate of interest being charged and is composed of the annual interest rate plus other loan fees such as origination fees, discount points, and buydowns. Under Regulation Z, a consumer has a three-day right to rescind (cancel) a credit transaction, but this right to cancel does not apply to residential first mortgages.
  2. Real Estate Settlement Procedures Act (RESPA) – RESPA applies to all federally related loans secured with a mortgage on one-to-four residential properties. RESPA requires the following:Disclosures are required at various stages in the loan and settlement process:
    1. Disclosures at loan application – Special Information Booklet, Loan Estimate, HELOC brochure, and servicing disclosure statement.
    2. Disclosures before loan settlement – AfBA disclosure and Closing Disclosure. AfBA stands for Affiliated Business Disclosure Arrangement.
    3. Disclosures at loan settlement – Initial escrow statement.

    RESPA prohibits anyone from giving or accepting a fee, kickback, or anything of value in exchange for referrals of settlement service business involving a federally related mortgage loan. Also, RESPA prohibits fee splitting and receiving unearned fees for services not performed. However, nothing in the law prohibits real estate agents from identifying and recommending service providers who will perform quality services for the client.

  3. Applying and Qualifying for a Residential Loan – To obtain a residential mortgage loan, a buyer must complete a loan application and submit it and any required supporting documentation to their mortgage broker. The completed application and supporting documentation will then be forwarded to loan underwriting. Underwriting is the qualifying process in which the loan documentation of the borrower is evaluated for approval or disapproval. The type of loan product selected and whether the product will be a conventional or government product will be determined by the borrower’s profile as it applies to the lender’s various qualifying ratios. Qualifying ratios are based on the type of loan program and its underwriting guidelines. Affordable housing programs and governmental programs, such as FHA and VA, all have unique qualifying ratios that apply.
  4. Residential Loan Types – Residential loans are either conventional loans or non-conventional loans. The term conventional is used to identify those loans that are not insured, guaranteed, or initiated by any governmental body. The majority of non-conventional loans are government loan products. Additionally, conventional loans may be classified as either conforming or non-conforming. Loan products that fall within the established maximum loan amount are known as conforming loans. Non-conforming loans are those that exceed the maximum loan amount.
  5. Conventional loan products – Following are the most common conventional loan products available in the marketplace:
    1. Fixed-rate loans – The fixed-rate mortgage remains the most popular conventional loan. The most common period for the loan to amortize (i.e., retire the debt in equal installment) is 30 years. However, for those borrowers wishing to retire the debt in less time, shorter fixed terms are available. A typical shorter loan amortization period is the 15-year loan. The fixed-rate loan usually calls for one payment each month.
    2. Adjustable-rate loans – When the interest rate for the loan is not fixed, it is an adjustable-rate mortgage (ARM). Interest rates for ARMs consist of an index rate plus a margin. Usually, this type of loan is used in cases where a borrower needs or wants a lower interest rate in the initial years of the loan. The index rate is the interest rate that reflects general market conditions. The margin The index changes based on the market. Changes in the index, along with the loan’s margin, will determine the changes to the interest rate for an adjustable-rate loan. The margin is the number of percentage points added to the index by the mortgage lender to set your interest rate on an adjustable-rate mortgage (ARM) after the initial rate period ends. Index + Margin = Loan Interest Rate.
  6. Government loan programs – The following are the most prevalent government loan programs:
    1. FHA loans – Among government loan agencies, the largest is the Federal Housing Administration (FHA). Today, FHA insures loans initiated by participating lenders. In essence, it places the credit of the U.S. Government behind the borrower by insuring the loan against default. When a default happens, the lender can recover losses from the FHA insurance pool. FHA mortgage insurance is called Mortgage Insurance Premium (MIP) to set it apart from insurance provided by Private Mortgage Insurance (PMI). MIP is paid by all FHA borrowers and is calculated to be sufficient to cover any loss.FHA loans are easier to qualify for than are conventional loans. An FHA loan will have a lower interest rate than a conventional loan, mainly if a buyer is unable to come up with a sizeable down payment and is obtaining both a first and second mortgage to finance a home. The cash investment of the borrower is minimal, thereby opening homeownership to persons who could not otherwise have purchased a home. Also, the qualifying ratios are more favorable to the borrower. MIP is required on all FHA loans regardless of the size of the down payment.
    2. VA loans – A VA loan offers military veterans many advantages over conventional financing. VA loan eligibility is based on the length of continuous active service. This minimum service ranges from 90 days to 24 months, depending on when the veteran served. Peacetime service requires longer times. National Guard and Reservists also have eligibility based on long-term service. Military personnel discharged dishonorably are not eligible. Spouses of veterans killed or missing in action or held as prisoners of war may also be eligible, so long as they haven’t remarried.The Department of Veterans Affairs issues a Certificate of Eligibility (COE). This certificate goes to the lender who will process the loan application and forward it to the VA. A VA appraiser must appraise the property, and the value is outlined in a document known as a Certificate of Reasonable Value (CRV). Once the lender approves the veteran borrower, the U.S. Government guarantees the loan. A VA loan does not require a down payment. The loan amount can be the sales price or appraised value, whichever is less. There is no maximum loan amount, nor are there income restrictions. VA underwriting standards are less stringent than conventional or FHA standards.

For more information on loan programs, it is essential to align yourself with a knowledgable mortgage broker who won’t hesitate to work with you and your clients. Mortgage brokers are usually open to establishing relationships with new agents, so it should be pretty easy to find one who is polite, professional, and works only in the best interest of your clients. If you can’t find one or two you are comfortable working with, just ask around your office for a few referrals.

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