In This Chapter

The preapproval process discussed in Chapter 13 covered many of the steps your clients will take to secure a mortgage. But preapproval only covers the buyer’s financial qualifications. In this chapter we’ll assume that your client has found a house he wishes to buy. If he has not been preapproved for a mortgage, your client must provide the financial information previously discussed, and you will need to order a credit report.

We’ll also review how the size of the down payment plays an important role in determining the rate and the lender’s approval. We’ll talk about different down payment strategies.

Moving beyond the information about the prospective borrower, we’ll focus on the property for which a loan is sought. Before the lender makes a decision on approving a mortgage, it must verify the property’s value and legal status. You’ll need to order a property appraisal, as well as a title search.

We’ll also review two other parts of the application that are designed to provide your clients with full disclosure of the actual price of the mortgage (Truth in Lending); as well as prevent possible bias in mortgage lending (Information for Government Monitoring Purposes).

Finally, we’ll tell you how to help your client determine when is the best time to lock in a rate, even if it costs him for the privilege.

As the mortgage broker, your job just got a whole lot more complicated.

The size of the down payment will affect the type of mortgage your client can secure. It also determines the amount of money that he will eventually repay. The larger the down payment, the less money he borrows and the smaller the repayment. Lenders see mortgages with larger down payments as more secure because the buyer has more of his own money invested in the property.

Traditionally, homebuyers were expected to put down 20 percent of the sale price. Those expectations are long since gone. Today there are programs to help buyers who have limited funds and can’t afford to put 20 percent down. There are programs to help buyers who can’t even afford any down payment.

But even for the average homebuyer, given the high prices of today’s housing, it’s a struggle. In this section, we’ll review some strategies you can suggest to buyers who want to boost their nest egg, as well as what you need to know about mortgages with minimal down payments.

VA loans permit zero down payments with limited closing costs, while down payments for FHA loans can be as low as 3 percent. While this helps qualified buyers who don’t have enough in savings for a down payment, you should remind these clients that they still must be able to afford the monthly payments.

Hopefully your client has carefully calculated how much money he has for a down payment before he walks in your door. But despite his best number crunching, you may be able to point out other sources of funding he hasn’t considered.

Lenders require buyers to pay for private mortgage insurance (PMI) if they can’t put down at least 20 percent. The insurance is the lender’s protection against the mortgagor’s default. The rates range from ⅓ to 1 percent of the loan balance per year.

Calculating the Real Cost of Mortgage Insurance

While at first glance it appears that the cost of mortgage insurance is minimal, you need to explain the financial ramifications. It may be your client’s only option since his finances are limited, but full disclosure is essential.

Let’s assume that your client wants to buy a house for $100,000, but only has $5,000 for a down payment. He can get a 15-year, fixed rate mortgage of 6 percent for $95,000, but will have to pay mortgage insurance of .56 percent of the balance per year for the first four years or until the owner’s equity or LTV (loan-to-value ratio) in the home drops below 80 percent and the insurance is no longer mandatory.

In simple terms, although he only needs an additional $15,000, he will end up paying a higher fee on all $95,000. Because he must borrow an additional $15,000, your client must pay an additional fee on the whole amount, not just the amount needed to make up the difference between a 5- and 20-percent down payment.

But if he doesn’t have the money, doesn’t plan to remain in the home for long, or even if he has the cash and can get a better return on his investment in other ventures, then the mortgage insurance may be a good option.

Mortgage Insurance Termination

The first few years of paying a mortgage, the owner is paying primarily interest. His equity in the home is slowly growing. But once it reaches at least 22 percent, the lender, by law, should terminate the insurance. However, the borrower may initiate termination of the insurance premium when the loan balance hits 80 percent of the original value.

Given amortization schedules, it usually takes about 10 years for a 30-year fixed rate mortgage to reach 80 percent of the property value; or almost 4 years if it’s a 15-year fixed rate mortgage.

To reach the 80 percent target sooner, the borrower could increase his monthly payments (which are applied directly to the principal). For a client who is short on cash for a down payment, but is expecting a steadily increasing income, this may be a good alternative.

The lender is not required to accept a request for cancellation if:

If the borrower’s loan was sold to Fannie Mae or Freddie Mac, the basis for cancellation is on the current appraised value of the property, rather than the value at the time the loan was made. Under these rules, the borrower can request cancellation after two years if the loan balance is no more than 75 percent of the current appraised value, and after 5 years if it is no more than 80 percent. The borrower must request termination and must secure an appraisal that is acceptable to the agencies and the lender.

If the borrower has a second mortgage, the property is held for investment rather than occupancy, or if the property is not a single-family residence, the ratios required for termination are lower.

Late payments will jeopardize early termination efforts.

If your client can only afford to put down less than 20 percent, you might advise him to consider a piggyback loan instead of paying mortgage insurance.

Again, let’s suppose that the price of the home is $100,000. The borrower puts down $5,000, and then takes out two loans: a first mortgage for $80,000; and at a higher rate, a second mortgage or home equity loan for $15,000.

Why is this preferable to mortgage insurance? Under this system, the borrower only pays a higher rate on $15,000. Mortgage insurance is calculated on the whole loan ($95,000). Furthermore, mortgage insurance premiums are not deductible, whereas the interest on the second mortgage is tax deductible.

The downside of piggyback loans, if tapped, is:

I always advise my clients to apply for a piggyback loan even if they don’t plan to use it immediately. You already have all the paperwork from the first mortgage application completed so the effort is minimal. I explain that the time to get a home equity loan is before you need it. It will be more difficult to secure one if you apply in the midst of a crisis—for example, if the client has lost his job. Instead, if you have it in reserve, it is there when you need it. There are no interest charges if you don’t use the money. As the mortgage broker, you earn a commission on both the first mortgage and the piggyback loan.

The mortgage insurance industry, in an attempt to stem the rise of piggyback loans that avoid PMI, has developed an alternative product. MGIC, the largest mortgage insurance company, now offers SingleFile. The borrower doesn’t pay a monthly mortgage insurance premium—instead the lender pays for the insurance.

Of course, the borrower does pay, but there isn’t a separate, nondeductible premium. Instead, the lender charges a higher interest rate (a quarter-point to half-point higher).

What’s the advantage over PMI? The mortgage business is very competitive, so lenders are more likely to cut the cost of the insurance charge to keep their rates attractive to borrowers. Cost comparisons reveal that the monthly payments of loans made with SingleFile are less expensive than comparable loans with PMI.

What’s the advantage over piggyback loans?

There are two drawbacks to this product. It is limited to low-risk borrowers who have excellent credit. It can’t be cancelled by having the house reappraised or by reaching a certain level of equity in the house. The only way to terminate the SingleFile loan is to refinance the house or sell.

Here are some points your client should consider when looking at piggyback loans, loans with PMI, and SingleFile.

You must arrange for the house to be appraised as part of the loan application. The lender will not approve the mortgage until it is established that the house is worth the amount of the loan. The fee for most appraisals is between $200 to $400. The purpose of the appraisal is to support the loan to value.

Appraisals must conform to Federal Reserve guidelines, but it is still a subjective process. The appraiser must determine the current market value of the house. This is especially difficult in a volatile housing market where prices are moving quickly and properties vary widely.

Appraisers can only use houses that have gone to closing as comparables. So they are working in effect 90 days behind. In a volatile housing market, when prices are rising rapidly, this can be a problem. The appraiser can note in his file Time Value Adjustments to indicate the rising prices of the houses.

The appraiser will compare the house to at least three other comparable homes in the area that have sold within the last six months. He must adjust for differences in the homes since clearly a completely renovated home will sell for more than one that hasn’t been touched in 25 years. The appraiser will physically measure and inspect the home. This is not a substitute for a home inspection. He will take photographs and will include them, along with floor plans (he may hand-draw them), and a site map in his report.

It’s a problem if the appraisal is lower than the sale price of the house. This happens if prices are rising quickly and comparable sales don’t reflect the change yet.

Make sure you use experienced, well-trained appraisers approved by the lenders you use. Ask the appraiser for his resumé, which should include the list of lenders for whom he is approved. Check credentials and ask for references. Appraisers are certified by the individual states under federal guidelines, but only half the states require licenses. Most states do require appraisers to pass a written exam, have 75 hours of continuing education, and serve 2,000 hours of direct experience through an apprenticeship.

By law the lender is required to give the client a copy of the appraisal. Here are some suggestions for dealing with a low appraisal:

If the appraisal is lower than the sale price, the lender accepts the lower number. They may still do the deal, but based on the appraisal figure. Ask the client if he is willing to increase his down payment or accept a higher interest rate. The lender may be willing to accept a low appraisal if the borrower has more equity in the property and the loan is smaller or pays off at a higher rate. If the client is convinced that prices in the area are going to rise (and that he’s just ahead of the curve), he may be willing to invest more and buy the house.

As part of the mortgage application process, you will need to order a title search of the property. It is a thorough examination of all public records that involve title (ownership) of that specific property. It is to guarantee that there are no liens or other claims against it except for those that will be cleared at closing.

Title searches usually go back 30 to 40 years (sometimes more). They involve researching past owners and deeds, wills, trusts, mortgages, judgments, and other liens to make sure that the title has passed correctly to each new owner.

Clouds, which are problems with the title, should be resolved prior to closing. For example, if a couple were both listed on the deed, but only the husband signed off at closing—even if the closing was 20 years previously and two sales had occurred in the interim—that would be considered a cloud on the deed and the wife’s interest in the property must be removed to clear the title.

Title searches should reveal rights held by others (for example, right of way, view easements, power line easements, mineral rights), claims by prior undisclosed heirs, and pending legal action.

Both the lender and the buyer generally purchase title insurance. This protects against losses that might occur after closing in the event that a previous owner’s rights were overlooked during the title search. Like most insurance policies, it’s rarely used, but is invaluable if a situation arises where title is in question.

The mortgage policy covers the lender for the life of the loan. If a new loan is issued and the current mortgage is paid off, then a new policy is required. The mortgage policy covers the amount of the mortgage.

The owner’s policy is also valid for the life of the loan. It covers the property’s full sales price, legal fees in defending the owner’s rights, and insures the owner against loss.

The policy covers problems that did not show up in the search or that were missed by the examiner. The insurance also covers errors in public records.

The policy does not cover defects that occur after the property is purchased. Unlike casualty insurance like for fire or flood, which protects against catastrophic events that might occur in the future, title insurance protects only against damaging events in the past.

Usually the policy doesn’t cover problems with easements, mineral and air rights, and liens. The borrower should ask for an explanation of all exclusions, and a recommendation for which ones should be resolved prior to closing.

Title insurance would cover hidden hazards, including forgeries, fraud, errors in recording the deed, defective foreclosures, faulty surveys, misinterpreted wills, conveyances by a minor or someone mentally incompetent, an undiscovered heir or ex-spouse who claims interest in the property, or a deed delivered after the death of the property owner.

Who pays for the owner’s title insurance varies from state to state and is based on local custom. There are no laws requiring either side to pay. For example, in Southern California, the seller usually pays for the owner’s policy for the buyer, and the buyer pays for the title insurance for the lender. In contrast, in Northern California, the buyer typically pays for both policies. However, like everything else in the sales contract, it’s open for negotiation.

The premiums are paid in full with a one-time fee, which is usually part of the closing costs. Typically, the fee is .5 percent of the purchase price, but this varies from state to state.

The rate also depends upon the kind of policy that is being issued.

As part of every mortgage application, your client will be asked to complete a short survey on race, gender, and ethnicity. It is designed to provide the government with data that monitors a lender’s compliance with the Equal Credit Opportunity Act. It’s against the law to discriminate on the basis of race, religion, age, color, national origin, receipt of public assistance funds, sex, or marital status.

The client has the option of refusing to provide the information (and can’t be discriminated against for refusing). But the law also requires that if the applicant doesn’t provide the information, the person taking the application, on behalf of the lender, is required to note the information on the basis of visual observation or surname.

The borrower and co-borrower are asked to check the following boxes:

The interviewer (who is taking the application) must provide his name, signature, telephone number, address of the interviewer’s employer, and answer the following question:

The federal government requires under the Truth in Lending (TIL) Act that within three days of a loan application, the lender provides a statement containing “good faith estimates” of the costs of the loan. The estimate will include the total finance charge and the annual percentage rate (APR). The APR expresses the cost of the loan as an annual rate. It’s higher than the stated contract interest rate on the mortgage because it takes into account points paid, mortgage insurance, and other fees that add to the cost of the loan.

As the mortgage broker, you may provide your clients with a TIL, and then the lender will provide one as well. There may be a difference between your estimate and the lender’s. This is usually because the client is uncertain which loan he wants when he applies. By the time the application is submitted to the lender for approval, the loan is designated.

Step by step, let’s review each part:

Lender:

Borrower:

Property Address:

The lender will check the points that are applicable to the borrower’s loan:

Disclosures about the variable rate feature should have been provided earlier.

SECURITY INTEREST: The borrower is being given security interest in:

FILING OR RECORDING FEES:

LATE CHARGE: If a payment is more than 15 days late, the borrower will be charged $ / % of the principal and interest past due.

If you pay off the loan early, the borrower:

The first question concerns penalties for paying off the loan early. Some loans charge a prepayment penalty. This section details whether a fee will be charged for paying off the loan before it is due.

The second question details whether the borrower will receive a refund for interest paid in previous years if the loan is paid off early. Although the borrower will not owe any additional interest, he will also not get a refund for prepaid finance charges and interest already paid in previous years.

This section details what insurance is required for the property.

INSURANCE: Credit life insurance, accident and health insurance, or loss of income insurance is not required in connection with this loan. This loan transaction requires the following property insurance:

Borrower(s) may obtain property insurance through any person of his/her choice provided said carrier meets the requirements of the lender.

ASSUMPTION: If this loan is to purchase and is secured by your principal dwelling, someone buying your principal dwelling,

Very few modern mortgages permit a buyer to assume the mortgage of the seller at the same rate and conditions. The lender will determine if the mortgage is transferable.

If mortgage rates are stable, your clients may be less concerned about locking in their rate. It’s more of a concern when rates are in flux and starting to rise. Part of your job as a mortgage broker is to keep close tabs on the trends in the economy (see Chapter 9). If you believe that rates are about to take off, you need to alert your clients and urge them to lock in.

Make sure your clients understand the difference between a rate quote and a rate lock. A lock is only valid if it’s in writing.

Locking in is a legal commitment. The lender guarantees a loan at a specific rate; the borrower agrees, under some circumstances, to pay certain points and fees to lock in that rate. Both parties agree to close on the loan by a specific date.

Most lenders don’t charge a fee to lock in a rate within 60 days or less of closing. But if the borrower wants to lock it in for a longer period, the lender will charge for that privilege. While the fees vary from lender to lender, generally lenders charge between a quarter and a half of a point for an additional 30 days.

Make sure that the fee is a refundable one. Since you can lock in a rate before a mortgage is approved, which might be preferable if rates are shooting up quickly, having a refundable lock-in fee is important in case the loan is denied. Even for those whose loans are approved, you want a refundable fee since it’s possible that circumstances could change; for example, the client could lose his job, and have the loan approval rescinded.

The lender will probably include a rate cap with the lock. It’s a margin, about a quarter of a point above the day of the lock-in’s rate, and if interest rates are higher at closing, the lender can charge the lock plus the margin. For example, if a borrower locks in a 30-year fixed mortgage at 5.5 percent with a .25 percent cap, at closing, even if rates have risen to 9 percent, the loan rate would only be 5.75 percent.

Many lenders also permit a one-time float down within 30 days of closing. In that case, if rates have fallen, the borrower can grab a lower rate at closing.

The Least You Need to Know