What a Lender Is Thinking…

Learning a lot from the real estate course. Right now we’re discussing lenders and their financing instruments. Ever wonder what a lending organization has in its collective mind when you apply for a loan? Here’s what an underwriter thinks about when he or she considers your application:

Credit: have you used credit responsibly in the past? Do you have a decent credit history?

Capacity: Do you have enough financial resources (income, wealth) to repay not just the proposed mortgage but also your existing debts?

Character: This subjective assessment has traditionally been defined as your “desire” or “willingness” to repay the debt.

Collateral: Is the value of the property to be mortgaged adequate to secure the loan?

Underwriters try to quantify their institution’s risk by calculating a “loan-to-value” ratio (LTV). To figure it, take the amount of the mortgage you’re asking for and divide it by the sales price or by the appraised value, whichever is lower. The result is the LTV, expressed as a percentage. The higher the LTV, the less the borrower has at stake in equity. Obviously, the less equity you have in a loan, the more likely you are to default, eh?

For example, at the time M’hijito and I bought the downtown house, it appraised at around $235,000. We borrowed $209,000 to buy it. Hmmmm….

209,000/235,000 = 88.9%

Today the place is worth about $180,000. Wanna see a figure guaranteed to give our lender heart failure?

209,000/180,000 = 116.1%

8-O

{gasp} We’ll just keep that between you & me & the lamp-post, hm?

Moving on, what does the LTV mean when you’re trying to get a loan? Well, for one thing, according to FHA guidelines, the amount of any insured mortgage may not exceed 97.65% of the property’s appraised value (make that 98.75% if the value is 50 grand or less).

So, again using the downtown house, the maximum FHA mortgage we were eligible for, back in the day when we thought the market had hit bottom, was

235,000 x 97.65% = $229,477

In other words, we borrowed about $20,000 less than we could have, in theory. To take the place off our hands today, the most a buyer could borrow based on its alleged current value would be $175,770.

Another factor that depends on the LTV is the maximum amount you, as a borrower, are allowed to contribute to various closing and ancillary costs. These include such nicks and dings as the origination fee, discount points, the cost of a credit report, appraisal fees, escrow, title insurance, recording fees, prepaid interest, taxes, homeowner’s insurance, and the like. The seller may pay all or part of your contributions, but the total can’t exceed the allowable maximum. How does this shake out?

If the LTV is greater than 90% on your principal residence, the maximum percentage of your contribution that may be paid by the seller is 2% of the selling price or appraised value, whichever is less.

If the LTV is 90% or less on a principal residence, the seller may contribute no more than 6% of the selling price or appraised value.

For a second home, if the LTV is 80% or less, the seller may contribute no more than 6%.

Any costs that are normally the buyer’s responsibility are considered to be “contributions” if the seller pays them.

 Who’d’ve thunk it?

 

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Evan April 23, 2012 at 1:51 pm

More amazing is when you think about how many of those rules were literally THROWN out the window during the 2005 – 2006 bubble

Coversure April 26, 2012 at 8:27 am

I used to arrange 2nd mortgages (in the UK) and the LTV is not really about your stake in the property, it’s more about getting their money back, if you DO default.

If the LTV is very high, then the mortgage co. need to sell the house for almost the full value to recover all of their money, which dependant on market and other conditions, they might not be able to do. With a much lower LTV this isn’t a problem, and if they are kind enough they might even sell it for more than the amount owed to them, so you could end up with something back yourself! Of course, that also means if your LTV rises above 95% you’re screwed.

Referring to the previous comment though, yes, for some lenders, if the LTV was low enough, things like income weren’t even taken into account! Mad but true…

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