Chapter 2
Introduction to Mortgage Lending
Learning Objective: To become familiar with the mechanics behind making a loan, what lenders look for in the process of granting loans and some of the differences between various kinds of lenders.
A. Fundamentals of Mortgage Banking
Mortgage bankers use their own funds, or funds borrowed from a warehouse lender, to fund mortgages. After a mortgage is originated, the loan has to be reviewed for approval in a process called underwriting where the loan is compared to predetermined guidelines that make the loan eligible to be sold.
A mortgage banker might retain the mortgage in their portfolio, or they might sell the mortgage to an investor or agency like Fannie Mae or Freddie Mac. Additionally, a mortgage banker might service the mortgage (collect the monthly payments), or they might sell the servicing rights to another financial institution. Most mortgage bankers do not retain the mortgage in their portfolio.
The distinguishing feature between a mortgage banker and a mortgage broker is that mortgage bankers close mortgages in their own names, using their own funds, while mortgage brokers facilitate originations for other financial institutions. Mortgage brokers do not make the final underwriting decision or close mortgages in their own names.
B. The Four C’s of Lending
The underwriting review or decision to make the loan or not is based on risk factors. The factors that are reviewed to determine the degree of risk are often referred to as the 4 C’s of lending - they are Capacity, Capital, Collateral and Credit.
Capacity
Lenders want to make sure the borrower has the ability to repay the loan. They will consider the amount and the stability of the borrower's income. Based on their experience with other borrowers, they assume that the applicant can safely spend a certain percentage (i.e. 34%) of his or her income for housing costs. Housing costs include not only the repayment of the loan(s), but other expenses associated with owning property, which include monthly expenses for property taxes, homeowners insurance, homeowners association fees (in the event the property is located in a planned unit development) and in some cases, mortgage insurance. The lender must determine the borrower’s level of income. The most common types of income that can be included are:
a. Hourly or Salaried Wages
b. Overtime, Bonus, or Commissioned Income
c. Self-Employment Income
d. Interest and Dividend Income
e. Investment Property Income
f. Alimony and Child Support
g. Social Security / Retirement Pension / Disability Income
The mortgage industry generally considers a two-year history as sufficient proof of stable income. Please note that wages in conjunction with (overtime, bonus, and commissions) as well as self-employment income and passive income (interest and dividend income, rental income) will be averaged to reflect the fluctuating nature of that income. Other passive income such as receivables and child support must also continue for a minimum of five years to be counted as income.
