Industry Basics

Introduction

The mortgage industry today is very different than it was as recently as 2 years ago. We are transitioning from record setting years of origination volume to normal market volume. This is a feast or famine industry. When the market is hot, the number of people and companies in the marketplace increases rapidly. Making money is easy; the skill level of an individual has little relationship to the money that person brings home. When the market cools, companies contract or go out of business resulting with across the board layoffs. No longer are applications easy to come by and only those who make the effort to hone their skills remain profitable in the business.

Market cycles are a normal condition of this industry. Each cycle has its similarities as well as its unique qualities. The most recent market correction occurred in the late eighties and early nineties. The unique attribute then was the collapse of the savings bank industry. This time around we’re faced with the impact of the Internet.

The Internet as a source for people to apply for a mortgage has been gaining market share year after year. This, however, is not the effect I’m concerned about. The real impact is the effect it is having on the way the consumer decides on making a purchase. It doesn’t matter if the consumer is buying a car, a home or applying for a mortgage. The company or individual who is providing the product or service no longer is the source of information used by the consumer. The Internet is. The Internet provides the consumer with an unlimited amount of information on any subject, product or service any time of the day or night. Most important, the data is available to the consumer while they are at work. So they are effectively getting paid to do their research.

Our jobs need to evolve from one of delivering information to the consumer to one of educating the consumer as to the best use of all the information they have assembled. The consumer feels empowered by all the information available. It becomes our job to prove to the consumer that having all the information in the world is meaningless without knowing what to do with it. Only an experienced mortgage professional can bring meaning to what they have found.

Only those who invest the time and effort to become a mortgage professional and are willing to go the extra mile will survive this market correction. If you didn’t believe this, you wouldn’t be here today.

The sections of the training manual covering the topics we’re addressing today are nothing more than an outline. We’re going to build off that outline with the goal of attaining a fuller understanding of the mortgage industry. This will make you a more valuable commodity in the business, which will potentially increase your income. In acquiring a complete understanding of State and Federal regulations you will be able to stay within all compliance guidelines, assuring yourself a long tenure in the business.

Since we are conducting business primarily in the State of New York I am going to keep our discussions focused on how business is conducted here. The regulations differ from State to State so if you are planning to conduct business any where outside New York you will need to get familiar with the laws of that particular State.

The Mortgage Industry and its Players

We are going to expand this topic to include all the players in a mortgage transaction and discuss each player’s role and focus. You’re here because you are interested in entering the industry or to enhance your basic knowledge of the mortgage business. The material that we are covering is relevant to the originator that is dealing directly with the applicant as well as the back office staff who will be dealing with the originator and various other individuals involved in the transaction.

Starting with the business entities we'll then go into the specifics of each job description.

To conduct business in the mortgage industry within the borders of New York State, a company needs to be a Licensed Mortgage Banker, Registered Mortgage Broker or an Exempt Organization. Exempt Organizations have a Federal Charter to conduct banking business throughout the country and are not held accountable to the New York State Banking Department. They answer to either the Federal Deposit Insurance Corporation (FDIC) or Office of Thrift Supervision (OTS).

Examples of Exempt Organizations would be Citicorp, Chase or HSBC. Large organizations will have internal compliance departments that develop policies and procedures that everyone in their organization need to follow as part of their job description.

Licensed Mortgage Bankers and Registered Mortgage Brokers answer to the New York State Banking Department and also need to be compliant with all Federal Regulations governing mortgage lending.

A Registered Mortgage Broker can be an individual or any form of a business entity. They are not required to maintain a predetermined net worth but are required to post a bond with the State. The size of the bond is reflective of number of mortgages originated by the particular broker. A broker cannot close a mortgage in its own name and it cannot issue a mortgage commitment. By State law the work done by a mortgage broker is strictly in the capacity of an advisor. Currently there is no educational or testing requirement to become a Registered Mortgage Broker.

A Licensed Mortgage Banker is required to have an adjusted net worth of $250,000, maintain a warehouse line of credit of a minimum of $1,000,000 with an unaffiliated banking institution and post a bond of at least $50,000.

The difference between a mortgage banker and broker is that a banker can lend its own money and a broker cannot. Notice I used the word “can” and not “does”. Bankers close mortgages in their own name in 3 basic ways.

They can use their own money. That is simply draw a check from their bank account. This approach is obviously limited by the liquid assets of the banker that’s why they need other options.

The next approach would be to use their warehouse line of credit. This is a single purpose credit line that a mortgage banker can draw off of to close on a mortgage. This is short term financing. The line is designed to be used to fund a mortgage between the time of funding until the time the mortgage is sold to the banker’s investor. Typically the agreement between the banker and the source of the warehouse line specifies the maximum time a mortgage can be in this transition state as well as what percentage of the mortgage can be funded off the line. This typically is 90%. In this approach the banker is limited by the credit limit of the credit lines (a banker can have multiple lines available) and the amount of cash available to fund the “haircut”. That’s the cash difference between what the line will fund and the actual balance of the mortgage that was closed.

The last approach is called table funding. Here the banker underwrites a mortgage application file. Before closing on the mortgage the banker transmits that file to the investor. The investor commits to taking this mortgage. Simultaneously the banker closes on the mortgage as the investor buys the mortgage. The banker is using the investor’s money to close with. Since the banker is not using any of its own money or drawing on its credit line to fund mortgages there is nothing limiting the number of mortgages the banker can close.

Why is this important to know? There are two reasons. The first brings us to the basic premise of lending. There is a direct relationship between the risk an investor is exposed to and the profit the investor expects to get. The mortgage that is funded with the bankers own funds exposes the banker to a much larger financial risk than the mortgage that is table funded. Therefore, the banker expects to make more money as a direct lender than when table funding.

This leads us to the second reason. When a banker is table funding or using his warehouse line all underwriting decisions are finalized by the investor. Any exception to policy or liberal interpretation of the underwriting guidelines is done by the investor, not the mortgage banker. When the mortgage is funded with the mortgage banker’s own money, the mortgage banker is the one making the final underwriting decisions. The mortgage banker is now holding that particular mortgage in its own portfolio making it a Portfolio Lender in this case.

From this an obvious conclusion can be drawn. A Portfolio Lender has more liberal guidelines but it will cost the borrower more.

Banking regulations make another difference between mortgage bankers and mortgage brokers. The mortgage broker, at first contact with an applicant, needs to disclose the services being provided to the applicant. The applicant is hiring the mortgage broker. The broker is working for the applicant and not for the bank. Although the regulation doesn’t specifically identify the broker as the agent of the applicant, there is an implied relationship. This is something mortgage brokers need to be aware of in the event there is a consumer complaint filed against him at the Banking Department.

A Registered Mortgage Broker’s involvement in a mortgage application is limited. The broker can advise the applicant as to the various mortgage products available, assist the applicant in assembling all the supporting documents necessary, submit the package to a lender and help the applicant meet any conditions that are noted on the mortgage commitment. The broker can’t issue a commitment nor can he close a loan in his own name.

The only difference between a mortgage that is closed through the use of a mortgage broker and that of a banker that is table funding the loan is the name on the mortgage documents. The broker’s file will have the investor’s name on the mortgage documents and the banker’s file will have the banker’s name on them.

Once the mortgage is closed, it takes on 2 lives. There is the income flow of the mortgage. That is the return to the investor. Whatever entity holding the mortgage gets the principal and interest payment from the borrower. In order to receive those payments there is an expense involved to the investor. Sending out monthly bills, clearing checks, billing and collecting late fees, sending out default notices, etc. This expense is the cost of servicing the mortgage. Some investors service their own mortgages, others farm out the work and simply pay a fixed cost to the servicing agent. This approach also has an added benefit. All liabilities associated with compliance issues relating to servicing the mortgage and handling the escrow account have been passed onto the servicing agent. Mortgage servicing is manpower intense. It requires an economy of scale for it to make sense for a company to service mortgages, typically major lending institutions service mortgages or companies whose sole business is mortgage servicing.

You should also keep in mind that even if mortgage payments are being made to a lender, the mortgage may still be serviced by a third party. Some banks want to look like they are servicing their own loans but do not have the desire to actually do the work. They will utilize a servicing company that operates in the background. Although the payments are made to the lender, a third party is actually handling the accounting on the mortgage.

We all know the mortgage rates offered by the industry change to reflect market conditions. This wasn’t always the case. Up until the late 1970’s the Federal Government regulated mortgages. All mortgages were fixed, and the rate was set in Washington. By regulating the cost of mortgage money consumers knew exactly what the initial costs and the ongoing costs of their mortgage would be before even applying for a mortgage. The downside to this was mortgage money wasn’t always available. The government can regulate the cost of a mortgage but they can’t, at the same time, force businesses to write mortgages. If the rate for a 30-year mortgage was regulated at 8.75%, which it was for many years, and a lender could earn a substantially higher yield on commercial lending or unsecured personal loans then their focus would lean to the higher profit areas. This is exactly what was happening.

To address this problem Washington allowed the mortgage rates to become market driven. This created a constant availability of mortgage money in the marketplace. It also greatly enlarged the secondary market. The secondary market is where lenders can take the closed loans out of their portfolio and convert them to cash. Money that can then be used to close new mortgages.

The secondary market is made up of many different entities. You have the Government Sponsored Entities (GSE) of Fannie Mae and Freddie Mac as well as all the Wall Street brokerage houses.

The brokerage houses meet the needs of the primary market (entities that are directly lending money to the consumer), which is to convert closed loans into cash. They do this by bundling those loans into large pools and sell those pools to entities that need a secure cash flow. These pools are then used as collateral to issue Mortgage Backed Securities (MBS). The brokerage houses then sell these securities. A pension fund that knows what its cash outlays will be in the upcoming years needs a conservative, predictable return to meet those obligations would be a buyer of these securities. A life insurance company would be another example of an entity that needs a predictable cash flow to meet certain obligations.

Investors who feel that interest rates are headed down will be another group that would buy these securities. Why? As rates go down the value of the securities go up. Lets take a simple example. You are the holder of a Note that yields 10% with a face value of $10,000. The annual interest you would receive is $1,000.00. Rates drop to 9%. Now a person holding a Note with a face value of $10,000 is receiving only $900.00 a year. Assuming the remaining term on both notes is same, the resale value of the 10% Note has increased to $11,111.11. Your Note is paying $1,000.00 per year in interest. The market rate is now 9.0%. What principal balance is needed to generate a $1,000.00 yearly return at 9.0%? 

$1,000.00 divided by 9%  = $11,111.11

Of course if the investor is wrong and the market interest rate increases to 11% the value of his Note has just dropped to $9,090.91.

$1,000.00 divided by 11% = $9,090.91

Fannie Mae and Freddie Mac operate similarly to the brokerage houses. Although they are independent corporations they have certain ties with the Federal Government. These corporations were created to meet 2 basic goals. Increase the liquidity in the mortgage market and to help more families achieve the American Dream of homeownership.

They achieve the goal of increasing liquidity in the marketplace through the enormous number of mortgages that they purchase from lenders and by creating standardization in the industry. There really wasn’t any standardization in the industry prior to 1968 when Fannie Mae began.

They contribute to the increase of homeowners in the country through the symbiotic relation they have with government. The GSEs develop programs specifically targeted to first-time homebuyers and operate under the supervision of the Office of Federal Housing Enterprise Oversight (OFHEO). The government’s contribution is granting them access to a credit line from the US Treasury and allowing them to operate with lower cash reserves than private industry is required to have. This lower cost of operation is then passed onto the marketplace. That’s why mortgages that are underwritten to conform to Fannie or Freddie standards carry a lower interest rate.

The Fannie Mae web site details the evolution of the GSEs from their initial creation in 1938 through their current form. It’s copied here for reference:

Early History
The FHA Administrator chartered Fannie Mae on February 10, 1938. The impetus for creation of Fannie Mae was twofold: the national commitment to housing and the inability or unwillingness of private lenders to ensure a reliable supply of mortgage credit throughout the country. The primary purpose of Fannie Mae was to purchase, hold, or sell FHA-insured mortgage loans that had been originated by private lenders. After World War II, Fannie Mae's authority was expanded to include VA-guaranteed home mortgages.

1954 Charter Act
The Charter Act of 1954 provided the basic framework under which Fannie Mae operates today but did not remove it from direct federal control. The act removed government backing for borrowings used to fund Fannie Mae's secondary market operations. It stipulated that Fannie Mae be exempt from all local taxes except property taxes, and provided for the Federal Reserve Banks to perform various services for Fannie Mae.

The 1954 Charter Act also defined the path by which Fannie Mae's secondary market operations would be transferred to the private sector: proceeds from gradual sales of common stock were to be used to retire Treasury-owned preferred stock in Fannie Mae.

1968 Charter Act
The 1968 Charter Act split Fannie Mae into two parts: Ginnie Mae and a reconstituted Fannie Mae. Ginnie Mae would continue as a federal agency and be responsible for the then-existing special assistance programs, and Fannie Mae would be transformed into a "government-sponsored private corporation" responsible for the self-supporting secondary market operations. The reconstituted Fannie Mae was to be stockholder-owned and managed. Fannie Mae retired the last of its government stock on September 30, 1968, and transformation to a government-sponsored private corporation was completed in 1970.

The 1968 Act provided the authority to issue Mortgage-Backed Securities (MBS).

The Act also established a regulatory structure to ensure Fannie Mae's adherence to its public purpose. It provided for continuing HUD oversight of Fannie Mae, granting "general regulatory power ... to insure that the purposes of this Title are accomplished."

Emergency Home Finance Act of 1970
The Emergency Home Finance Act of 1970 created Freddie Mac and authorized it to create a secondary market for conventional mortgages. Parallel authority and limitations to deal in conventional mortgages were given to Fannie Mae.

To alleviate credit concerns raised by acquisition of conventional mortgages (that lack federal backing), several eligibility restrictions and/or risk sharing requirements were imposed on the mortgages Fannie Mae could buy.

The new law also required the HUD Secretary to provide prior approval of Fannie Mae's "purchase" or "dealing in" conventional mortgages (later interpreted by HUD regulations in 1995 to require specific approval of new and different conventional "programs").

Secondary Mortgage Market Enhancement Act of 1984
The Secondary Mortgage Market Enhancement Act of 1984 ("SMMEA") clarified and modified several of HUD's regulatory powers over Fannie Mae. It required HUD to respond within 45 days to any request for new program approval made by Fannie Mae under the Charter Act (with a 15-day extension permitted) and authorized Fannie Mae to purchase and deal in subordinate lien mortgages.

Financial Institutions Reform, Recovery, and Enforcement Act of 1989
The Financial Institutions Reform, Recovery, and Enforcement Act ("FIRREA") of 1989 made regulation of Fannie Mae and Freddie Mac consistent. Until 1989, Freddie Mac was owned by the Federal Home Loan Bank System and its member thrifts and governed by the Federal Home Loan Bank Board (later reorganized into the Office of Thrift Supervision). FIRREA severed Freddie Mac's ties to the Federal Home Loan Bank System, created an 18-member board of directors to run Freddie Mac, and subjected it to HUD oversight.

Also, the GAO and Treasury were instructed to conduct studies of Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. These studies laid the foundation for comprehensive regulatory modernization for both Fannie Mae and Freddie Mac in 1992.

The Federal Housing Enterprises Financial Safety and Soundness Act of 1992
The Federal Housing Enterprises Financial Safety and Soundness Act ("FHEFSSA") of 1992 modernized the regulatory oversight of Fannie Mae and Freddie Mac. It created the Office of Federal Housing Enterprise Oversight ("OFHEO") as a new regulatory office within HUD with the responsibility to "ensure that Fannie Mae and Freddie Mac are adequately capitalized and operating safely." OFHEO is funded by assessments on Fannie Mae and Freddie Mac and is authorized to act without HUD oversight on a range of regulatory issues enumerated in the statute. FHEFSSA established risk-based and minimum capital standards for Fannie Mae and Freddie Mac. And, it established HUD-imposed housing goals for financing of affordable housing and housing in central cities and other rural and underserved areas.

The Federal Government also has avenues where it takes a more direct role in homeownership. This is done through the Federal Housing Administration (FHA) and the Veterans Administration (VA). Neither of these agencies actually lends money. What they do is guarantee the mortgage.

FHA mortgages gives consumers access to the mortgage market in cases where they or the subject property would not be eligible. Properties in need of repair, applicants with little or no credit history or applicants with little or no cash are just some of the problems that can be solved with an FHA mortgage. The higher risk of default due to these types of issues will either force a lender to decline the mortgage or force the applicant to a lender that specializes in problem deals. Of course, a lender who specializes in problem mortgages (a subprime lender) will be charging a rate that is reflective of the higher risk of default.

By using an FHA guarantee, a lender can transfer their risk of default from their portfolio to FHA. All the lender needs to do is to see to it that the mortgage conforms to FHA guidelines. FHA guidelines are more lenient, but even they have their limits.

VA guarantees were created to help military personnel buy their homes. The main focus here is to reduce the down payment requirement. Just as in the FHA program the intention is to transfer the higher risk of default to the government to encourage lenders to close more loans.

As the industry became more experienced with analyzing each component of a mortgage applicant they have become more capable in predicting default risks. This has lead to the development of risk based pricing. Simply put, if you can predict the percentage of a pool of mortgages with a specific weakness, no money down, no credit, etc. that will go into default you can then determine what yield is necessary on that pool to cover the risk of default of that percentage.

The mortgage market today consists of a range of products and underwriting guidelines that can accommodate the needs of almost any applicant. Pricing on this range runs from the lower cost Fannie Mae conforming mortgage all the way through to the subprime market. This availability of mortgage money has brought the percentage of Americans who own their own home to nearly 70%.

We’ll finish up this section with an overview of the individual job descriptions of the business with the intention that you will develop an understanding of where each person fits in the process. No matter how automated this business becomes, you are going to be dealing with people in assorted positions. Your dealings with these individuals will go much smoother if you understand where they are coming from.

The Seller – As the individual selling the property he’s interested in closing on the sale at the price he contracted for and a timeframe that meets his needs. It’s rare that any one of us will have any direct dealing with the seller but when problems arise, the seller will be pressuring others, who will then be pressuring you. He will have an indirect impact on you. Something to keep in mind when you’re dealing with the person who is “caught in the middle”.

The Buyer – All he wants to do is buy a house. He’s caught in a flurry of activity, usually doesn’t understand all the details of what’s happening around him, has a lot of questions that he may or may not be afraid to ask, has friends and relatives throwing advice at him with varying degrees of correctness and most of all, is well aware that he ultimately is paying for everything that is confusing him. He is the one person you will be dealing with that is outside the business. Don’t talk to him in businessspeak. When discussing anything with him, take the time to explain what he doesn’t understand and answer his questions in English. It will make your life easier and the buyer won’t be afraid to talk to you.

The Real Estate Agent – Representing the Seller, you would assume that his interests are aligned with the seller. When the agent is doing his job right, this is the case and he should be available to help the deal move to closing. One of the unfortunate effects of the explosive real estate market we just went through is that the professionalism of the industry has suffered. The attitude of most agents today is to push the transaction to close as soon as possible. This results in unnecessary friction on all parties involved. You need to always be sure that a “rush” is real and not just something that has been originated by a frantic agent.

The Attorney – It doesn’t matter whether he’s the seller’s or the buyer’s attorney. Conversations are rarely with the attorney directly, it’s usually with his paralegal and sometimes you may not be dealing with the same paralegal on each phone call. Your conversations will be much more effective if you maintain notes from previous conversations and assume that the person you are talking to is not as familiar with the issues as you are. You always need to keep in mind that the person you’re talking to is not an attorney and may not be as familiar with the Law as an attorney would be. The paralegal is very often “caught in the middle” and you need to recognize that if you want to get anything done.

The Engineer – He’s hired by the buyer to do a visual inspection of the house. He doesn’t have x-ray vision nor can he read minds. His inspection doesn’t guarantee the condition of a house; all he can do is confirm that the buyer didn’t miss any obvious defects. You will find yourself having to explain that to buyers and to people in the industry that really should know better.

The Originator – This is the person that has direct contact with the buyer, or in the case of a refinance, the homeowner and the processor. When dealing with the buyer he will typically forget that he his delving deeply into an individual’s personal life. If the originator isn’t respectful, he’s not going to get the complete picture that he needs. If he doesn’t explain why he needs something to the buyer, chances are he’s not going to get everything he needs. He will often argue with a processor, when he’s asked to get additional documentation or to get a question answered. All parties press the originator and his stress level often ignites when problems arise.

The Processor – This is the individual who preps the file to be underwritten. This is a critical position in the approval process and doesn’t get the respect it deserves. The better the processor is at his job, the easier the underwriting process becomes and the faster a commitment is issued. The processor is the link between the originator and the underwriter and is dealing with the originator’s desire to get a application committed and the underwriter’s responsibility that a commitment meets all the appropriate guidelines.

The Appraiser – The appraiser’s job is to determine the fair market value of the subject property. Appraising is more of an art form than a science. The appraiser is doing an objective third party review to confirm that the agreed upon contract price is at least the fair market price. He is caught between the desire of the buyer, real estate agent and originator to bring in the property as high as possible and the lender’s desire to keep the appraisal as conservative as possible. As the real estate market cools the lender will direct the underwriter to a detailed review of appraisal reports to confirm that the market value is properly supported by the data provided. In a hot real estate market, the rapid rate of appreciation reduces the risk of a generous appraisal report. In a declining market you will find almost every appraisal report is criticized forcing an appraiser to do twice the work on each report.

The Underwriter – This is the decision-making position. The underwriter is responsible to assure that the mortgage he commits the lender to will perform after it closes. The underwriter’s pressure comes from different areas of the bank he is working for. The sales and marketing side wants to close as many mortgages as possible and therefore is looking to the underwriter to interpret guidelines as liberally as possible. The banks secondary market department wants the mortgages underwritten as conservatively as possible to minimize the bank’s exposure in buying back non or under performing mortgages. The compliance department will be watching over the underwriting staff to confirm all disclosures are issued timely and that all applications are underwritten in a consistent manner. Let’s not forget the processors who are looking get their packages out of underwriting as quickly as possible.

The Title Closer – This person represents the title insurance company at the closing. The title insurance company guarantees to the buyer that he will have clear and marketable title to the property he just purchased and guarantees that the lender’s lien position is valid. He is not a decision maker. If a question arises regarding title at a closing, his responsibility is solely to relay that problem accurately to the title company. The title company then decides on the appropriate action that needs to be taken.

The Bank Attorney – The representative from the closing attorney’s office is to see to it that all the necessary documents are signed, and remaining closing conditions are met and funds are properly dispersed. Again this is not a decision making position. The bank’s closing attorney can only relay a question to the bank and then follow the bank’s instructions. It is important that there are no serious open issues at the closing. Lenders will adjourn a closing before rushing to resolve a problem at the last minute.

It doesn’t matter what position you eventually take in the mortgage process. The better understanding you have of the roles of all the players the easier your job will be and you will become a more valuable asset to the company your are associated with.

The Life of a Loan

When a person decides that he wants to buy a home he will need to address the question of affordability.  The client will come to you directly or because a realtor told him he needed to be prequalified. You need to keep in mind there are differences between how much a person qualifies for, how much he can afford and much he feels comfortable paying. All these things need to be considered in this discussion. You can’t loose sight of the fact that when you are dealing with 2 buyers, a husband and wife for example, each one will have different comfort levels.

From an originator’s prospective, this is the most important meeting you will have. It is during this discussion where you prove yourself. The potential buyers need to feel that you have their best interest in mind. You need to impress them with your knowledge of finance. If you can succeed in doing these things, you now have a client. Follow through with them to a smooth closing and you have a client for life.

Remember what I pointed out earlier. The vast array of mortgage programs currently in the marketplace allows us to arrange financing for nearly all borrowers. A good originator’s responsibility to the client doesn’t end there. He needs to be sure his clients know what they’re getting into and that they feel confident they can make the mortgage payments. You are not their parents. You have no right to tell them what to do. You do have a responsibility to give them an accurate estimate of what it is going to cost to purchase the home they’re interested in and compare that cost to what they are currently paying. It then becomes their responsibility to decide if they can live with the payment.

Prequalifying an applicant is the process of assembling a snapshot picture of the financial condition of the applicant and then relating that picture to a hypothetical purchase. Based on your discussion with the applicant, you will know what documentation you will need to see. For example, a salaried applicant would have pay stubs whereas someone self-employed would not. From this documentation and the credit report the applicant allowed you to run you can determine how much of a mortgage the applicant can qualify for under a full income verification program.

Based on the discussion with the applicant and comparing what is said to what is documented, you may need to look at how much of a mortgage the applicant can get under some form of a reduced verification program.

Taking this one step further, you may want to make a recommendation as to the affordability for the applicant to use a no-doc mortgage or a no ratio mortgage.

It’s obvious that this step in the process can be very involved. It requires an investment of time both from the originator as well as the applicant. If the applicant is rushed or is not forthcoming with the necessary information the originator will not be able to do his job properly. If the originator isn’t giving his full attention to the details of this discussion he will not be able to do the job properly. Prequalifications cannot be done as you’re running out the door or between telephone conversations. It needs your undivided attention.

Once an applicant is prequalified, the originators work isn’t done. As the applicant proceeds with the house hunting, questions will arise. Different areas have different property taxes or maintenance costs. The search may have widened to include properties that have some form of rental income. Any number of property related issues would impact the maximum mortgage this applicant can qualify for. The financial condition of the applicant may change. Change of a job, loss of overtime, a relative offering to gift the applicant a large sum of money, an emergency that depletes the liquid assets of the applicant, etc. are just some of the possible changes that can occur on the personal level that the originator needs to hear about. Market rate changes, product guideline revisions, new products being offered are important events that the originator will have access to and would need to bring to the applicant’s attention.

Prequalification is not a one-time event. It is an ongoing process that ends once the applicant finds the house he wants and enters into a contract to buy it. At that point the application process begins.

Because of all the work that was done through the prequalification stage, this step becomes very simple. The originator needs to have an application package filled out and signed by the applicant. He then needs to assemble the supporting documentation that will be required. This can be done in a face-to-face meeting, over the phone, by mail or via the Internet. Each approach has its own advantages and disadvantages. Whatever the originator feels works, will be the path taken. At this point the processor takes over.

When the originator submits the file for processing, it should be complete. The more preparation the originator has done, the easier the file is to process and underwrite and the faster the commitment is issued.

The processor will confirm all documents that are required to be signed at application are in the file as well as all the required supporting documentation. Depending on how much paperwork is missing, the processor will either request the missing documents from the applicant or give the file back to the originator while reminding him what is expected from him. If any verification forms need to be sent out, they are sent out now, and a new credit report is run.

The processor then orders the appraisal and forwards out to the applicant any disclosures that need to be executed at this stage. The processor needs the appraisal and all signed disclosures in the file before the file can move to the next level.

The originator would have discussed locking options with the applicant by this time and a decision was made. The processor would have been told if the rate was to be locked and for what period. The processor will now take the appropriate course of action. If instructed to do so, the processor will also order a title report. This is typically handled by the buyer’s attorney but in some cases the processor is instructed to place the order.

After the processor completes his job the file is then moved to the underwriter. The underwriter expects a complete file, with all disclosures signed as well as instruction identifying what loan product the applicant is applying for. A decision is made and the file goes back to the processor. The processor will send out a decline letter to the applicant or a commitment depending on the underwriting decision.

The decline letter will notify the applicant of the reason for declination. The commitment letter will identify the detail of the offer, the status of the rate lock and list any closing conditions that need to be met. The applicant is then expected to accept the commitment and return it signed along with any closing conditions to the processor. The processor forwards the file back to the underwriter to clear any open conditions and then the file moves to the closing department.

The closing department will review the title report, confirm they have everything in their file from underwriting and review the homeowners insurance on the property. They are now ready to prepare the closing documents and close on the mortgage.

At this point both the borrower’s and seller’s attorneys are notified that the lender is ready to close. Once both buyer and seller are ready to close, the bank’s attorney is contacted and the date is set.

On a purchase the lender is required to have the proceeds of the mortgage available to be drawn against on the day of closing. If the mortgage is a refinance or a second mortgage on a person’s primary residence and that residence is a 1 to 4 family dwelling, this is not the case. Borrowers that are closing under these circumstances are given a 3 day right of recission under federal law. That is, the actual closing doesn’t take place at the closing table. It takes places 3 business days later. All documents are dated for that date and interest accrues on the mortgage from that date. The borrower can cancel within that 3-day period for any reason and receive a refund of any money that was paid in connection with the mortgage.

The regulation specifically states that the 3-day period starts immediately from the point the borrower knows exactly what his closing costs and terms of the mortgage are. If a lender wants to, and some do, they can start the recission period once the loan is locked and all the terms and cost associated with the mortgage are delivered to the applicant. Since the penalties are severe it has become common practice for lenders to execute a “dry closing” where the paperwork is signed and no money changes hands. By having every penny accounted for (by having a completed closing taking place) and the Note (the legal agreement between the lender and the borrower identifying the obligations of both parties) signed to begin the recission period, the lender is guaranteeing they are in full compliance.

Three entities survive the end of the closing, or recission period in the case of a refinance. We have a homeowner with guaranteed ownership in the property. There is a mortgage, a lien on that property that secures the interests of the mortgagee. The mortgagee is the entity with a security interest in the property. It may be the lender that signed the commitment or another entity that became the mortgagee at the closing table. Then there is the servicing agent. This company could be the lender who signed the commitment, it could be the mortgagee, or it can be a totally new entity. The servicer is the entity that will be billing the borrower monthly for the mortgage payment and then pass that money through to the appropriate parties. Does it matter to the borrower? No, the terms of the mortgage that has been filed against the property and the terms of the Note that was executed by the borrower and the lender dictate the rights of the parties. Will the borrower always have the same mortgagee and servicer for his mortgage? Probably not, the mortgage and the servicing contract are assets that can be bought and sold on the secondary market. This is really no different than a stock or bond. Should the borrower be concerned about this? No, mortgages are an investment from a lender to the borrower. They are bought and sold regularly in the secondary market. Since the borrower doesn’t have any direct dealings with the mortgagee he wouldn’t even be aware that his mortgage has been sold. The borrower does have an ongoing relationship with the servicer, so a change in servicing is an important fact for the borrower to be aware of. He certainly doesn’t want to send his monthly payment to the wrong company.

To insure a smooth transition from one servicer to another the government has specified through regulation, exactly how it is to occur. Both the old servicer and the new servicer need to notify the borrower at least 30 days prior to the date the change is to occur. The borrower is informed though these notifications the date of the transfer, the name and contact information of the new company as well as the new account number. This way the borrower will recognize the new servicer when he receives his first bill.

When the time comes that the homeowner wants to pay off his mortgage, he simply contacts the current servicer and notifies them of his intentions. The servicer will provide a final bill (a pay off letter) and upon receipt of the funds issue a receipt of payment (a mortgage satisfaction). If the homeowner is paying off the mortgage with his own funds, he then takes the Satisfaction down to the appropriate county clerk’s office and files it, erasing the lien. If he is refinancing his mortgage, the title company that is insuring the new lender’s lien will arrange for receipt and filing of the Satisfaction. The same thing will occur if the home is being sold. The title insurer will take responsibility for the filing.

Introduction to Compliance

The mortgage industry is one of the most highly regulated industries in the country. The reason for this is that we are dealing directly with consumers and with their largest financial transaction. As an industry we are governed by several Federal Agencies as well as the Banking Department of the State of New York. Staying compliant across multiple regulatory bodies is complicated by the fact that the guidelines are written by lawyers and politicians. This leads to guidelines that aren’t specific and are typically open to various interpretations. This means you must be careful as to what you say or do.

Real Estate Settlement Procedures Act (RESPA)

RESPA was written to prevent kickbacks in a real estate transaction. It essentially states that there can be no payments made to any entity in a real estate sale for any services that were not actually performed.  Every cost paid by the consumer, either directly or indirectly, must be itemized. A “Good Faith Estimate” of closing costs must be given to an applicant within 3 days of an application being taken. Since you are originating the mortgage, you are responsible for issuing this disclosure.

You are also responsible to comply with the Truth in Lending Act (TILA). TILA requires a disclosure of the true cost of credit to the applicant during that same 3 day period. This act requires you to calculate the Annual Percentage Rate (APR) on each application. The APR is a calculation that factors in the note rate of the mortgage and certain closing costs that are considered to be a prepayment of interest. This, in theory, alerts the consumer as to the true cost of credit of the mortgage they are applying for and can then compare it to other sources of financing.

Since you will be required to make this disclosure also, this would be a good time to explain what this disclosure is all about. Back in the 70’s, mortgage rates were set by the Federal government. Everyone  paid the same rate, no matter where in the country they bought a home. When it was 8 ¾% in New York, it was 8 ¾% in Florida. If the cost of money went up and it wasn’t particularly profitable for a lender to make money in the home mortgage market, they simply wrote less mortgages until the Federal government raised the rate. With the inflation rate increasing and the public having more places to save their money besides the basic savings account, something needed to be done to stabilize the flow of money into the mortgage market.

The government’s response was to allow the mortgage rate to become a free market rate. As the cost of money would increase, so would the mortgage rate. When the cost of funds would go down, so would the mortgage rates. At the same time the GSE’s, FANNIE MAE & FREDDIE MAC, came into play as a place for lenders to sell off their mortgages, if they chose to. Making mortgage rates responsive to market conditions permitted a consistent flow of money into the mortgage market.

Once lenders had some pricing flexibility, they began to look for ways to differentiate themselves from each other. One way they did this was by introducing the concept of points. A lender could offer a lower interest rate by collecting points up front on the loan. The government said this is all well and good, but a disclosure would have to be made so the consumer could compare different rate and point combinations. The A.P.R.(Annual Percentage Rate) was created. The APR is a blend of the note rate and any upfront interest charges.

Let’s take an example. Let’s say you are borrowing $100,000 @ 8% for 30 years. The monthly payment would be $733.76. If, however, you paid 2 points you really didn’t receive $100,000 you only received $98,000 ($100,000 – 2 points). You are now required to recalculate the interest rate based on a mortgage amount of $98,000, a monthly payment of $733.76 over a 30 year term. Your new interest rate is 8.21%. This is the APR. Now over the years additional charges have been deemed to be prepayment of interest and also must be added in to the upfront finance charges. This makes the calculation a little more complex, but the theory behind it is still valid. It gives the consumer a wake up call that the real cost of the mortgage is higher than the note rate. How much higher is dependant on certain up front costs. If the disclosure is read by the applicant, it will generate the question. That really is all the disclosure was meant to do.

Home Owners Equity Protection Act (HOEPA)

(HOEPA), also known as Section 32. This is a form of consumer protection, written to protect the public from predatory lending in refinancing. A mortgage will fall under this Act if it meets either of the following thresholds. First there is the rate test. If a mortgage is written with an interest rate, which is 8% or more above a similar term T-Bill for a first mortgage or 10% or more above a similar term T-Bill for a subordinate mortgage, the mortgage will need to comply with the additional restrictions imposed by this Act. Then there is the fee test. If the closing costs exceeds 8% of the mortgage amount or $547.00 whichever is higher, then again the mortgage will need to comply with the additional restrictions of the Act. Section 32 requires additional disclosers and more stringent consumer protections making it more burdensome for a lender to seek legal recourse in the case of a default. Since a borrower can easily lose the equity of the home or lose the home completely in a foreclosure action, the penalties in violating this act are severe.

Any lender involved in closing on loans with costs of such a magnitude that they are either close to being a HOPEA loan or have crossed the threshold into a HOPEA loan, have a high potential for financial liability. They will closely monitor your actions to protect themselves.

Part 38 of the New York State Banking Law

If you are working as an originator for a mortgage broker, you need to be aware of what needs to be disclosed to an applicant at first contact. Here’s the list.

1.   You do not make mortgage loans or commitments.

2.   You cannot guarantee acceptance into any particular loan program.

3.   Your services are advisory and administrative in nature.

4.   You are being authorized by the applicant to assist them in securing financing. You will counsel them on available mortgage products, general mortgage qualifications, their financial capabilities and meeting conditions of the loan commitment.

5.   If you work with 3 or fewer lenders, you need to state that and identify the lenders.

6.   You need to state the rate, points, fees and other terms quoted at commitment by or on behalf of the lender encompassing the consideration to be received by you from the lender for your services.

7.   You will need to disclose the maximum amount of such consideration to be received. Since this disclosure is made at first contact and you cannot commit a lender to make a mortgage, it would be impossible to specify the exact compensation you will receive from the lender.

8.   You need to show the amount of the application fee, processing fee and a good faith estimate of the cost of the appraisal and credit report, and the terms and conditions for obtaining a refund of such fees, if any.

9.   You will need to show the specific services, which will be provided or performed for the application fee and the processing fee.

10. You need to disclose the points paid from the applicant to you for compensation for your services. You also need to disclose when the fee is payable, it cannot be any earlier than at the time the commitment is accepted by the borrower.

11. Any premiums or bonuses to be paid by the lender to you as well as on what basis or eligibility there is for receiving the premiums or bonuses.

12. If the transaction involves more than one mortgage broker, a co-broke situation, then this must be disclosed as well as the terms of the co-broke.

13. You must disclose that certain mortgage products impose a prepayment penalty. You will disclose the amount of, or the formula for calculating, the prepayment penalty, and the terms of the prepayment penalty, if any, as soon as you know them.

14. You must give them the name and phone number of a person in your company that can be called for questions regarding the application. If your applicant lives greater than 50 miles from your office you must provide them either with an 800 number or be willing to accept collect calls from them.

15. If you are placing loans with private lenders, that is a lender that is neither an exempt organization nor licensed pursuant to Article 12-D of the Banking Law, you must disclose that. Therefore, certain consumer protections will not apply to the loan.

At the time of application, the only fees you can collect are the application fee and the estimated costs of the appraisal and credit report. If you are collecting a processing fee, you can collect it only at closing. Remember there can only be one application fee and one processing fee paid per mortgage. If your lender is charging either one, you cannot.  These fees, as all fees regarding a mortgage, must be reasonably related to the services performed on behalf of the applicant. Neither fee can be based upon a percentage of the principal amount of the loan or the amount financed.

If you are taking the application electronically, that is via the Internet, then your e-mail address must also appear on the pre-application disclosure.

Part 41 of the New York State Banking Law:

New York State’s response to predatory lending concerns is found in Part 41 of the Banking Law. This regulation went into effect in October 2000. Just as in HOEPA, there are 2 threshold tests to see if a mortgage will fall into the high cost category. Here the fee threshold is 5% of the mortgage amount, without any alternative minimum dollar amount. The rate test is 8% over the Treasury rate for first liens and 9% for any subordinate liens.

Any charges received by the lender or an affiliate of the lender including all compensation paid to a mortgage broker are used to calculate the fee threshold. The only fees that are not included in the total are bona fide discount points, money collected in escrow for taxes or insurance as long as the charges are not ultimately being paid to an affiliate. A point is presumed to be a bona fide discount point if it reduces the interest rate by a minimum of 35 basis points (approximately 3/8%).

These tests apply for mortgages written on primary residences only and for loan amounts below the FNMA limit or $300,000, whichever is lower (Currently the FNMA limit for all property types is greater than $300,000 making the threshold $300,000 in all cases). The mortgage can be for purchases or refinances and the borrower must be a natural person. The debt incurred by the borrower is primarily for personal, family or household purposes.

If you are originating a mortgage that will fall into this category, the following will apply:

1.   No call provision. No high cost loan may contain a call provision that permits the lender, in its sole discretion, to accelerate the indebtedness. This prohibition does not apply when repayment of the loan has been accelerated by a bona default, pursuant to a due-on-sale provision, or pursuant to some other provision of the loan agreement, unrelated to the payment schedule such as bankruptcy or receivership.

2.   No balloon payment less than 7 years. The department has discovered a high number of mortgages that were written with very short balloon periods, sometimes less than 1 year. It became obvious to the department that these loans were written for the sole purpose of forcing a refinance as quickly as possible, so new fees can be generated.

3.   No negative amortization. Negative amortization is created when the required monthly mortgage payment is not high enough to even pay the interest due for the month, so the shortfall of interest payment is added onto the mortgage amount. Negative amortization is a powerful tool under the right circumstances, however the department has found lenders abusing the tool and responded by restricting its use.

4.   No increased interest rate.  This doesn’t mean a high cost loan can’t be an adjustable, what it does mean is that in the case of the loan defaulting, the interest rate can’t be increased. The premise here is that the rate is already high enough and therefore no increase is warranted.

5.   No advanced payments. You cannot incorporate into the mortgage amount more than 2 future mortgage payments. For example, a mortgage closing in January cannot have February’s through June’s mortgage payments paid directly out of the proceeds of mortgage at the closing.

6.   No modification or deferral fees. You cannot refinance a high cost loan into another high cost loan, and charge fees for it. If you are refinancing a loan from a high cost loan to one that is not, the interest rate must drop by 2%. If the refinance is a cash out situation, a lender can only charge closing costs on the new money and those costs must be in line with the closing costs normally charged by that lender. In other words you cannot increase the closings costs on the new money to make up for the fees you are not entitled to on the original mortgage amount.

7.   A list of approved counselors must be provided to the applicant. The list is provided by the Banking Department and it is your obligation to give the list to the applicant. Counseling is not mandatory, just the disclosure is.

8.   No lending without due regard to payment ability. This is an attempt to eliminate pure high cost equity lending. If the borrowers’ disclosed income is no greater than 120% of the median family income for the Metropolitan Statistical Area (MSA) in which the subject property is located, then you must be able to prove that the borrower can reasonably expect to afford the monthly payments. This was in response to lenders writing mortgages in which their only goal was to foreclose on the property. Remember if the applicant discloses an income greater than this threshold, then this restriction doesn’t apply.

9.   Financing of points, fees or charges. In making a high cost purchase mortgage loan, a lender cannot require an applicant to incorporate any fees in excess of 5 percent of the mortgage amount into the mortgage amount. The key phrase here is – require. Should the borrower elect to finance any or all of his closing costs into the mortgage, he certainly can. The lender, however, cannot make it mandatory. In the case of a refinance, the lender cannot finance more than 5 percent of the mortgage amount to cover closings costs. This is the case even if the borrower wishes to, or has no other way to pay the additional costs. This is done to protect people from themselves.

10. Frequent refinancing of high cost loans. This section only applies to a lender refinancing its own high cost mortgage and all refinances originated through mortgage brokers. In refinancing one high cost mortgage into another, fees can only be charged on the new money, the part of the mortgage that is over and above the balance of the existing high cost mortgage. These fees can only be in line with the lender’s typical point and fees structure for high costs loans.

11. Restrictions on home improvement contracts. A lender cannot disburse directly to a home improvement contractor. Checks must be drawn directly to the borrower, issued as two party checks or if the borrower requests it, to a third party escrow agent with a specific agreement between the agent and the borrower as to the conditions specifying when the money is to be released to the contractor.

12. Detail the actual effect of the new monthly payments. In addition to the standard Part 38 disclosures, this additional disclosure must be made, when applicable. “Although a borrower’s aggregate monthly debt payment will decrease, the high cost home loan may increase both (i) a borrower’s aggregate number of monthly debt payments and (ii) the aggregate amount paid by a borrower over the term of the high cost loan.” Again, if this is not the case, this disclosure does not need to be made. Remember this disclosure must be made at least 3 days prior to closing.

13. Reporting requirements to credit agencies. Lenders must report both the favorable and unfavorable payment history of the borrower to a nationally recognized consumer credit bureau at least annually.

14. Referral Sources disclosure. Mortgage brokers and lenders must report to the Banking Department annually, on or before March 31st in each year, the names and addresses of the three home improvement contractors, the three consultants and the three attorneys who provide the most referrals, if any and the three to which the broker or lender make the most referrals, if any. They must also provide the names and address of any home improvement company that is an affiliate.

15. High Cost Mortgage acknowledgement. The following statement must appear above the borrower’s signature line on the application: “The loan which will be offered to you is not necessarily the least expensive loan available to you and you are advised to shop around to determine comparative rates, points and other fees and charges.”

16. Unfair and deceptive acts or practices. This last section of the regulation addresses how you conduct business. If you meet any of these standards, then you are deemed not to meet the requisite character and fitness to be licensed or registered by the State.

• The making of high cost home loans that demonstrate a pattern and practice of violating any provision of this part. The provision of this section shall apply to any lender that seeks to avoid its application by any device, subterfuge or pretense whatsoever.
• Engaging in any unfair, deceptive or unconscionable practices in the course of advertising, brokering of making high cost home loans.
• Brokering or making a high cost home loan which includes points, fees or other finance charges that, considering the loan transaction as a whole (including creditworthiness of the borrower, the terms of the loan, the value of the collateral, and the owner’s equity in the collateral), so significantly exceeds the usual and customary charges incurred by the consumers in this state for such points, fees or other finance charges as to be unconscionable.
• Brokering or making high cost home loans in which the broker or lender charges fees and retains fees paid by the borrower for services that are not actually performed or for which the fee bears no reasonable relationship to the value of the service actually performed.
• Brokering or making high costs loans with repayment terms that so exceed the borrower’s financial capacity to repay as to be considered unconscionable.
• Flipping high cost home loans, that is, brokering or making a high cost home loan to a borrower that refinances an existing mortgage loan when, considering all the circumstances of the refinancing, such refinancing is unconscionable.
• Packing high cost home loans. That is, the practice of selling credit life, accident and health, disability or unemployment insurance products or unrelated goods or services in conjunction with a high cost home loan without the informed consent of the borrower. Specifically when the broker or lender solicits the sale of the goods or services, receives compensation either directly or indirectly or are prepaid with the proceeds of the loan by being financed as part of the principal amount of the loan.

17. Recommending or encouraging default or further default by a borrower on an existing loan or other debt, prior to closing on a high cost home loan that refinances all or any portion of such existing loan or debt.

18. Advertising that refinancing pre-existing debt with a high cost home loan will reduce a borrower’s aggregate monthly debt payment without also disclosing, if such are likely the case, that the high cost home loan will increase both (i) a borrower’s aggregate number of monthly debt payments and (ii) the aggregate amount paid by a borrower over the term of the high cost mortgage loan.

Truth in Lending in Advertising

If you quote a rate in an advertisement you must also quote the APR for that product. The APR must be at least the same size and font as the rate quoted. No “fine print” is allowed when disclosing the APR. NYS requires that if you are advertising a particular product and/rate you have to be able to prove that you have the product available for a reasonable number of applicants. This is to prevent blatant “bait and switch” marketing.

If you’re a mortgage broker, you need to identify that you do not make loans. That’s why if you look closely at an ad placed by a mortgage broker you will see the phrase “all loans arranged through third party providers”.

Equal Credit Opportunity Act (ECOA)

The title of the act sums up what the act does. It mandates that a lender cannot discriminate against any applicant based on race, sex, martial status, national origin, age or religion.

The Home Mortgage Disclosure Act (HMDA)

HMDA is a requirement that lenders need to provide a report to the government that discloses the distribution of declined mortgage applications among different ethnic groups. The reasoning behind this is to make the lenders aware that their underwriting decisions are under constant surveillance by the public. Remember all that is being reported are declines broken down by ethnic group. The reason for each individual decline is not part of the report. This severely limits drawing accurate conclusions from this data.

Community Reinvestment Act (CRA)

This Act requires that banks honor their obligation to serve all communities equally. Communities need to be served by bank branches. Money needs to be invested in a community to make it economically strong. Banks will be audited to confirm that the areas they serve though bank branches are also being served through lending. The concern is simply that a bank can’t go into a community, take deposits in and then lend outside that community.

Fair Housing Act

This affects real estate professionals more than mortgage professionals but we are still expected to comply. Obviously, blockbusting and racial steering is more likely to be an issue with those who are actually selling property. A lender can get into a problem situation if there is a pattern of lending in their geographic area that correlates with the ethnic make up of the area. The term “redlining” came about because there was a time when lenders would have a map posted in their office with specific areas lined in red to identify communities they would not lend in.

Government regulators as well as the court system will generally favor the consumer over a lender. Lenders are assumed to have deep pockets. Put these two conditions together and you can see why lenders tend to err on the side of caution. Every lender or broker, no matter how small their operation is, will have a focused effort on compliance. A large lender will have a compliance department, a small shop may have one person that’s responsible. Wherever you work there will be someone telling you what you need to do to stay in compliance and that individual also serves as the person to whom you will bring any compliance questions you have. If you find that the company you are associated with doesn’t have a person responsible for compliance, then you should consider working somewhere else.

A major component for staying in compliance is having a documentation trail in your files to confirm that the applicant has been notified of everything he should have been told and in the proper timeframe. The way this is done is by having a signed and dated acknowledgement of receipt of every disclosure.

The following is a list of the more common disclosures that need to be given to the applicant during the process:

On Application:

1.       Signed Application – Commonly identified as the 1003 (pronounced “ten-o-three”). Shorthand for the document created by FNMA and labeled Fannie Mae Form 1003.

2.       Pre-Application Disclosure and Fee Agreement – This only applies for mortgage brokers.

3.       Occupancy Certification – The applicants acknowledges how he plans on using the subject property; primary home, second home or as an investment.

4.       Authorization to Release Information – The applicant grants your company permission to run his credit, verify employment, etc.

Within 3 days of Application:

1.       GFE – The good faith estimate of closing costs is an itemized breakdown of all the costs associated with the loan being applied for. It’s a good faith estimate since it is subject to change as the process continues.

2.       TIL – The truth in lending statement needs be issued by a lender, not brokers

3.       FACTA – Fair and Accurate Credit Transaction Act disclosure. This is needed when a credit report is run. It notifies the applicant that he is entitled to a copy of his report and when a copy is given a disclosure is attached listing his rights.

At Commitment:

1.       The commitment letter – The lenders offer to the applicant.

2.       GFE – Updated if necessary

3.       TIL – Updated if necessary

4.       Servicing Transfer Disclosure – Lets the applicant know that servicing may be assigned to a different company and historically how often that has happened.

5.       PMI – Private mortgage insurance disclosure if applicable.

6.       Lock-in agreement – if applicable.

7.       Copy of Appraisal – Applicant must be given the option to request a copy of the appraisal report.

At Closing:

1.       Lender’s attorney fee disclosure – The actual bill for the attorney’s services

2.       Final GFE

3.       Final TIL

4.       Servicing Transfer Disclosure

5.       Right to Cancel – Owner occupied refinances and seconds only.

6.       HUD Settlement Statement – An itemization of all charges relating to the closing.

You’ll notice there is a lot of duplication of the disclosures. Staying in compliance is such an important consideration that at every opportunity during the process updated disclosures are issued just to be sure. It’s better to have too many signatures, than not enough.

Types of Loan Programs

We going to start with the general types of underwriting guidelines and then we’ll move into a brief description of the more common mortgage programs.

In general the more documentation that is required on a program, the better the pricing is. So we are going to start with the lowest priced program and move up to the most expensive.

General Categories of Programs:

FNMA Conforming - This is a program that conforms to the FNMA underwriting guidelines. The loan amount is within the conforming limit, credit is good to excellent, income and assets are verified.

Jumbo Loans - These mortgages are underwritten to FNMA standards except that the amount of the mortgage exceeds FNMA guidelines. Jumbo mortgages typically are 0.25% to 0.375% higher in rate than conforming mortgages. The pricing difference between conforming and jumbo will come into play with the rest of the types we are going to discuss.

Stated Income – Here we are not going to document the income flow of the applicant but we will be providing documentation supporting his assets. Why would an applicant be willing to pay a higher rate for the luxury of not supplying documentation supporting his income? There are several circumstances when this approach is used. The applicant may have a complicated income flow. Self-employed with several different corporate entities to deal with or tax returns haven’t been finalized yet are just 2 possibilities. Maybe the applicant is in an all cash business or his income isn’t consistent year to year. These are all reasons to use this program.

Stated Income & Stated Asset – Here we don’t supply income documentation or proof of assets.

No Ratio Loan – Here we are listing the source of income but not the amount. In a stated income program the income stated must be reasonable to the job that the applicant has. For instance it’s not likely that a maid is earning $100,000 a year but a doctor can easily make that salary. Under a No Ratio program we just list the job without any income figures. This program can also be offered in conjunction with no asset verification.

4506 – The IRS form 4506 (8821 for corporations) is a form that grants the lender permission to request summary data from the IRS so they can verify that the income shown on the application matches the income that was claimed on the 1040. This form is typically part of the application package when originating a full income/full asset verified mortgage. Especially when the applicant is self-employed and therefore there is no third party verification of income. Typically, it is also signed as part of the closing package even with stated income programs. There are 2 reasons for this. The first is that in the event the mortgage goes into default, the mortgagee can check to see if insufficient income was a contributing factor. The second reason is that a percentage of closed mortgages are reviewed for quality control. If an applicant is applying for a stated income product he needs to be made aware of the fact that this form may appear at closing. If he is not comfortable signing it he will need to stay in a no ratio program, and pay the higher rate. It is the originator’s job to make the applicant aware of the details and then allow the applicant to choose what path he wants to take.

Specific Program types:

Fixed Rate Mortgage – The simplest and oldest mortgage type. The mortgage rate is fixed for the term of the mortgage and as a result the mortgage payment remains constant.

Adjustable Rate Mortgage – Typically identified as an ARM. Here the risk of a changing interest rate environment is transferred from the lender to the borrower. The lender has a guaranteed profit between their costs of funds and the interest collected on the mortgage. The borrower gains the benefit of a lower interest rate than a prevailing fixed. ARMs will vary as to the frequency of the adjustment period. It can adjust daily (as is typical in Home Equity Mortgages), monthly, 6 months, 1 year, 3 year or 5 years. The interest rate is determined by an index value that the lender has no control over, plus a margin. The most common index values are Prime Rate, 1-year Treasury or LIBOR (London Inter-Bank Offered Rate). The margin is a constant that when added to the index rate gives the actual rate charged on the mortgage for the upcoming period.

Hybrid ARM – These mortgages have become popular over the last several years. As the name implies, the idea is to create a mortgage that has the security of a fixed rate and the lower interest rate of an ARM. Typical Hybrid ARMS would be 3/1, 5/1, 7/1 or 10/1. A 3/1 would have a predetermined fixed rate for 3 years then become a 1-year ARM, a 5/1 would be fixed for 5 years before becoming a 1-year ARM, etc. The longer the fixed rate term is, the closer the rate gets to a fixed rate. The theory here is that the average life of a mortgage is historically 5 to 7 years, so why not design a mortgage product that gives the security of a fixed rate only for the time needed and not the life of the mortgage.

Home Equity Line of Credit (HELOC) – This is special type of mortgage. It can be used in a first or second position. Here the mortgage balance can increase or decrease at the borrower’s choice. The minimum payment is interest only and the amount of principal pay down is entirely up to the borrower. This type of mortgage comes with check writing privileges. It permits the borrower to increase the outstanding balance on the line (up to the credit limit) simply by writing a check. The following month’s payment will be based on a higher principal balance to reflect the draw.

Interest Only Mortgage (I/O) – A typical mortgage payment includes a portion of the payment that is applied to reduction of principal. If the mortgage is written as an interest only mortgage then the payment is reduced to the interest component only with no principal pay down. Principal is paid either as a balloon (payment of the entire principal balance) after a predetermined time period or the mortgage begins to amortize (monthly principal pay down as in a standard mortgage) at a certain point. The majorities of I/O mortgages written today are designed to be I/O for 10 years and then amortizes at the same interest rate for the remaining term. If it was originated as a 30-year mortgage you would have a 10-year I/O period followed by a fully amortized mortgage for the remaining 20 years. In order to minimize the payment shock at the 10-year point lenders have begun to offer 40-year mortgages. Some are even beginning to offer 50-year mortgages.

When an I/O feature is added onto a mortgage program the interest rate will be increased. As an example we will take a 30-year fixed rate mortgage at a rate of 6.25% and compare it to its I/O version with a 0.25% increase and a 0.375% increase. Doing this will allow you to compare the payment saving each month to the actual cost of using this feature.

After the first year there was a saving of $7,553.16 ($62,803.20 - $55,250.04) in monthly payments compared to the 6.5% I/O payment. The trade off is that the total interest paid for the money increased by $2,407.15 ($55,250.04 - $52,842.89) and the outstanding balance on the mortgage is still $850,000 instead of dropping by $9,960.11 ($850,000.00 - $840,039.69). If you compare it to the 6.625% I/O payment you'll see that the total interest increase by $3,469.63 ($56,312.52 - $52,842.89). Let's look at what happens at year 2 and 3.

After year 3 there was a savings of $22,659.34 ($188,409.46 - $165,750.12) in monthly payments compare to the 6.5% I/O payment. Now the total interest paid for the money increased by $9,184.66 ($165,750.12 - $156,565.46) and the principal balance of the mortgage didn't drop by $31,844.14 ($850,000 - $818,155.86).

Fixed Payment Mortgages - These are the most complicated mortgages that have ever been designed by the industry. You'll see them identified as COFI, COSI, Option Payment or other variations. COFI is the index value for the mortgage; it's short for the 11th District Cost of Funds Index. The 11th district represents the West Coast and the region where this mortgage type began. COSI is an index that reflexes the yield on saving accounts. Option Payment focuses on the ability of borrower to choose what payment is going to be made. This mortgage was designed to meet the needs of two classes of borrowers. They are the high net worth individuals that find the flexibility of this product very appealing or the second group, made up of those who need lower monthly payments in the short term, at any cost.

This type of mortgage creates a new term in mortgages, that is payment rate. The payment rate is the rate that is used to determine the payment for the first year.

Let’s start by walking through the reasoning that is responsible for the creation of this product. Problem: How to reduce the monthly payment on a mortgage? If you start with the traditional fixed rate you can reduce the payment by making it interest only. You can reduce the interest rate by making the mortgage an adjustable rate. Now you have an adjustable I/O mortgage but you still want to deliver a lower monthly payment, what do you do? The lender needs to get a certain yield on the mortgage, or it doesn’t make economical sense to be in the mortgage business, so lowering the rate isn’t an option. The only option available is to design a negative-amortization mortgage. If an amortizing mortgage means that a portion of the principal balance is paid down on each payment then a loan with negative amortization means that the principal balance increases on every payment. The lender effectively lends the borrower additional capital each month. Seems dangerous and it is. This is a product that an originator needs to spend a lot of time explaining to a client.

The best way to explain how this product works is with an example. We start with a $100,000 mortgage. The interest rate (that is index rate plus margin) on the Note will be 7.0%. This is a monthly adjustable. The payment rate shall be 2.0%. The loan will have a 7.5% annual payment cap, a 10% maximum negative amortization cap and a lifetime interest rate cap of 12%. Let’s begin with looking at what all this means. This is a monthly ARM so the interest rate will change each month. As I noted in the ARM section, adding the index value to a margin makes up the interest rate on an ARM. The payment rate is used to determine the original mortgage payment and nothing else. If there were never any increase in the monthly payment the principal would just continue to go up every month. This can’t happen for obvious reasons so the mortgage payment is designed to increase by a predetermined amount each year. In this case that’s a 7.5% increase. If the index rate climbs dramatically the amount on negative amortization could get out of hand. To prevent this there is a 10% cap on the amount the mortgage can increase over the life of the mortgage. What this means is that if the principal balance increases to $110,000 in our example, the monthly payment would immediately have to increase enough to meet the interest accrued for that month. The interest rate on this mortgage can never exceed 12%, no mater how high the index value should go.

Now we can look at the numbers. $100,000 @ 2.0% for 30 years gives us a payment of $369.62. This payment will remain the same for 12 months, then it will increase to $397.34, at the 24th month the payment will increase to $427.14, and so on. The actual mortgage rate is 7.0% (for this example we will assume the index rate isn’t changing) so the interest that is due on month 1 is $583.33. Only $369.62 was paid resulting with the balance of the mortgage increasing to $100,213.71. Month 2 carries an interest payment of $584.58 due to the higher principal balance.

Remember this is based on no changes to the index value. In reality there will be changes. The majority of consumers that get involved in this type of mortgage don’t realize all its features. They are focused on the initial monthly payment and nothing else. This is why the originator is obligated to invest the time needed to give a complete explanation.

Reverse Mortgage – This is a unique type of mortgage available only to senior citizens. Depending on the age of the applicant and the equity in the home, a senior citizen can receive money without any other investigation or any requirement to make monthly payments. This mortgage is designed to allow a senior citizen to stay in his/her home while living off of the home’s equity.

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