For the average person, borrowing the money required to purchase a house is the largest financial obligation they are likely to assume in their lifetime. It’s an extremely important decision—second only to the selection of the property itself. When acting as your real estate agent, I always encourage caution and careful consideration before signing a promissory note. Even if you locate financing that feels acceptable early on, shopping around for a loan from several different lenders is still an excellent idea.
To help you better understand the mortgage loan process, here are some of the common steps you will take throughout your home-buying journey.
After deciding that a real estate loan is necessary, the first step in obtaining the loan is filling out a loan application. As mentioned, it is a good idea to shop around and check for the best rate and terms at various lenders before applying because—despite what many suspect—every lender is different. Finding the right loan is as important as finding the right piece of real estate. The application will require detailed information regarding both the property and the borrower.
The application generally receives a preliminary screening to determine if there are any obvious or glaring reasons why either the prospective buyer or the property could not qualify for a loan. This process is accomplished by credit scoring. It is followed by a professional appraisal of the property and an independent investigation into the credit background of the applicant. The lender wants to know how likely the borrower is to meet monthly payments and pay back the loan. This is analyzed with reference to the borrower’s capacity and desire to pay.
If loan analysis proves favorable and financing terms are acceptable to all parties, it is then time to get the terms of the agreement down on paper. Processing involves typing up the loan documents, preparing necessary disclosure statements, and issuing instructions to the escrow holder.
All the paperwork of the loan transaction ends up in escrow, along with all the other contracts involved in the purchase of real property. The trust deed and promissory note are signed and passed along to the escrow company where the deal is closed.
Loan servicing involves mailing monthly loan statements, collecting payments, and ensuring that all records are kept up to date. Some lenders service their own loans, while others hire independent mortgage companies to handle the paperwork for them. Loan servicing also involves all correspondence for late and delinquent payments.
How Do You Qualify for a Loan?
All lenders set their own standards for evaluating who qualifies and who does not qualify for a mortgage loan. These standards are reflected in the interest rates charged. Some lenders have very strict requirements, while others take a greater risk—but charge a higher rate of interest, especially on second trust deeds.
Traditionally, lending institutions decided whether or not a borrower was qualified based upon a simple formula: the property should not cost more than two-and-a-half times the buyer’s annual income. Today, however, many lenders recognize that this method is inadequate. It fails to take into account other debts that the borrower may be paying off, and doesn’t give the middle income buyer—or those entering the housing market for the first time—much of a chance with today’s high cost real estate.
New rules of thumb consider a borrower’s other debts along with the housing payments. Long term debts are added to these payments and the sum is referred to as the borrower’s total monthly expenses.
One standard rule was that a borrower’s total monthly expenses should be no more than 36% of all total monthly income. Now, in California, it is closer to a 3½ to 1 ratio. Another rule applied to borrowers who are not heavily in debt elsewhere requires that their annual income be approximately 30% of the cost of the property. This is a variation on the traditional formula, and reflects a more realistic attitude on the part of lenders.
How Does the Appraisal Influence the Loan Process?
Just as the borrower is evaluated during the loan process, lenders evaluate the property being purchased. They want to be certain that the price being paid reflects a fair market value. If a property is overpriced and the borrower defaults, it may be difficult for the lender to recoup the amount of the loan. This process of determining a property’s fair market value is known as appraisal.
Institutional lenders are not likely to lend the entire amount needed for the purchase of a property. Most often, they will determine its fair market value and lend a set percentage of that amount. This “loan to value ratio” (or LTV) is generally 80% to 90% at banks and savings banks, and 70% if the loan comes from an alternative lender. Collateral is required, but most often the property itself, including any structures, is used as security for alone.
Next Steps: Let’s Connect
Now that you know the basics of the loan process, you are well equipped to make the right decisions when it comes to one of the most important purchases you will ever make. To get more tips on purchasing your next home—and help finding it—contact me today for a free analysis and home-buying checklist.