Assignment 13 Mortgage Underwriting and Borrower Qualification Flashcards
Which one of the following statements is TRUE?
- The loan-to-value constraint is used by lenders to assess the level of income risk, whereas the debt service ratio constraints are used by lenders to assess the level of capital risk.
- Subprime mortgages represent the majority of residential mortgage lending in Canada.
- The mortgage approval procedure for a residential borrower only requires the examination of the borrower’s personal income as the source of funds to make mortgage payments.
- Character, as a part of the five “Cs” of credit, is a subjective opinion based on the borrower’s current employment situation, educational background, business experience, length of time at current residence, etc.
Correct Answer: 4
Option (4) is correct because character, as a part of the five “Cs” of credit, is a subjective opinion based on the borrower’s current employment situation, educational background, business experience, length of time at current residence, etc. Option (1) is incorrect because the loan-to-value constraint is used by lenders to assess the level of capital risk, whereas the debt service ratio constraints are used by lenders to assess the level of income risk. Option (2) is incorrect because prime (not subprime) mortgages represent the majority of residential mortgage lending in Canada. Option (3) is incorrect because the approval procedure for a residential borrower involves examination of the borrower’s income as well as other credit analysis and the appraisal of the home pledged as security against the loan.
Jordon Liu has just been hired for a new job, which pays an annual salary of $50,000. Jordon would like to purchase a home closer to the new workplace, and requires a loan of $200,000 over a 25-year amortization period with monthly payments. Property taxes are $1,500 per annum and the market interest rate is 5.45% per annum, compounded semi-annually. What is the gross debt service ratio?
- 32.16%
- 29.59%
- 39.42%
- 26.35%
Correct Answer: 1
Option (1) is correct because the GDSR is 32.16%. This question solves for the GDSR, given the loan amount, property taxes, and borrower’s income. First, the monthly loan payment must be calculated. The monthly loan payment is then multiplied by 12 to determine the annual mortgage payments. Then add the property taxes to this amount and divide the total by the borrower’s annual salary in order to derive the GDSR.
PRESS
DISPLAY
5.45 ⬛ NOM%
5.45
2 ⬛ P/YR
2
⬛ EFF%
5.524256
12 ⬛ P/YR
12
⬛ NOM%
5.389131
200000 PV
200,000
25 × 12 = N
300
0 FV
0
PMT
−1,214.968222
1214.97 × 12 =
14,579.64
+ 1500 =
16,079.64
÷ 50000 =
0.321593
Which one of the following statements regarding the stress test borrower qualification rule for uninsured mortgages is TRUE?
- The mortgage qualifying rate is based on the lesser of the Bank of Canada’s 5-year benchmark rate and 2% above the mortgage’s negotiated contract rate.
- The British Columbia Financial Services Authority established the stress test requirements for all new mortgages from federally regulated financial institutions.
- The stress test mortgage qualifying rate is the greater of the government-specified qualifying rate or the borrower’s mortgage contract rate plus 2%.
- The stress test qualification rules only apply to commercial mortgages from federally regulated financial institutions.
Correct Answer: 3
Option (3) is correct because the stress test mortgage qualifying rate is the greater of the government-specified qualifying rate (j2 = 5.25% as of June 2021) or the borrower’s contract rate plus 2%. Option (1) is incorrect because the mortgage qualifying rate was previously based on the greater (not lesser) of the Bank of Canada’s 5-year benchmark rate and 2% above the mortgage’s negotiated contract rate. In 2021, the qualifying rate changed to the greater of a qualifying rate of 5.25% or the borrower’s mortgage contract rate plus 2%. Option (2) is incorrect because the Office of the Superintendent of Financial Institutions (OSFI) established the stress test requirements for all new mortgages from federally regulated financial institutions. Option (4) is incorrect because the stress test qualification rules only apply to residential mortgages from federally regulated financial institutions.
A lender is reviewing a borrower’s mortgage loan application. The borrower has an annual income of $75,000, first mortgage payments of $1,500 per month, car payments of $500 per month, and annual property taxes of $3,000. Which one of the following provides the correct gross debt service ratio (GDSR) and total debt service ratio (TDSR) for this borrower?
- GDSR = 25%; TDSR = 33%
- GDSR = 26%; TDSR = 34%
- GDSR = 27%; TDSR = 35%
- GDSR = 28%; TDSR = 36%
Correct Answer: 4
Option (4) is correct because the GDSR is 28% and the TDSR is 36%.
GDSR = PIT ÷ Gross Income
GDSR = [($1,500 × 12) + $3,000] ÷ $75,000
GDSR = 28%
TDSR = (PIT + Other Debt)¸ Gross Income
TDSR = [(($1,500 + $500) × 12) + $3,000] ÷ $75,000
TDSR = 36%
Which one of the following statements regarding lending constraints is TRUE?
- For insured mortgage loans, the maximum loan-to-value ratio is set by statute at 80% for federally chartered financial institutions.
- The total debt service ratio does not consider other debt obligations of the borrower.
- A lender’s primary concern is ensuring they receive an above-market yield.
- The gross debt service ratio is usually defined as the ratio of the sum of the annual mortgage payments (principal and interest) and annual real property taxes to annual gross income.
Correct Answer: 4
Option (4) is correct because the gross debt service ratio is usually defined as the ratio of the sum of the annual mortgage payments (principal and interest) and annual real property taxes to annual gross income. Option (1) is incorrect because the maximum loan-to-value ratio is set by statute at 80% for uninsured mortgage loans. With mortgage loan insurance, borrowers may obtain up to 95% as the maximum loan-to-value ratio. Option (2) is incorrect because the total debt service ratio includes other debt obligations of the borrower, e.g., additional financing, car payments, maintenance fees, and credit card payments. Option (3) is incorrect because a lender’s primary concern is default. In order to obtain protection against default, lenders can restrict the loan so that only a specified portion of the borrower’s income will be needed to repay the mortgage debt.
Which one of the following statements is TRUE?
- Market value is a long-term conservative estimate of the value of the property pledged as security for a loan.
- Lending value is determined by standardizing a number of specific, observed transactions to produce an estimate of what the property might sell for in the current market under strictly defined circumstances.
- The lending value of a property is generally less than market value, sometimes equals market value, and almost never exceeds market value.
- The purchase cost is the specific amount that the property will trade for, as negotiated between the vendor and the purchaser.
Correct Answer: 3
Option (3) is correct because lending value is a long-term conservative estimate of value, lenders may set the lending value to be a lower value than the market value. It would be risky for lenders to set lending value greater than market value. However, sometimes lenders may use the market value as a representation of lending value. Option (1) is incorrect because lending value is a long-term conservative estimate of the value of the property pledged as security for a loan. Option (2) is incorrect because market value is determined by standardizing a number of specific, observed transactions to produce an estimate of what the property might sell for in the current market under strictly defined circumstances. Option (4) is incorrect because the purchase cost equals the purchase price plus all legal, appraisal, credit analysis, and associated fees, plus any bonus that may be charged on a mortgage. The purchase price is the specific amount that the property will trade for, as negotiated between the vendor and the purchaser.
A ballet dancer has recently moved to Vancouver to work for the BC Ballet Company and has applied to a local bank for a mortgage loan to finance a $400,000 condominium purchase in Vancouver. The borrower’s income is $65,000 per year. The bank will apply a 39% gross debt service ratio when calculating the maximum loan. Current mortgage rates are 4.25% per annum, compounded semi-annually for 25-year amortization mortgages and the government-specified qualifying rate is 5.25% per annum, compounded semi-annually. Annual property taxes are $3,990 and mortgage payments are to be made monthly. What is the maximum mortgage loan the bank will grant, given the stress test borrower qualification rules for uninsured mortgages? Round your final answer to the nearest dollar.
- $298,699
- $201,534
- $329,877
- $271,863
Correct Answer: 4
Option (4) is correct because the maximum mortgage is $271,863. The maximum loan under the GDSR constraint must be determined. To determine the allowable annual mortgage payments, multiply the borrower’s annual income ($65,000) by the GDSR (0.39) and deduct the annual property taxes for the year ($3,990). This yields total allowable mortgage payments for the year of $21,360, or monthly payments of $1,780. The minimum qualifying rate is based on the greater of the government-specified qualifying rate of j2 = 5.25% or the contract rate plus 2%. In this case, apply a rate of j2 = 6.25% (2% + 4.25%), which is greater than the government-specified rate of j2 = 5.25%.
P + I = (GDSR × Gross Income) – Property Taxes
P + I = (0.39 × $65,000) – $3,990
P + I = $21,360 per year = $1,780 per month
PRESS
DISPLAY
6.25 ⬛ NOM%
6.25
2 ⬛ P/YR
2
⬛ EFF%
6.347656
12 ⬛ P/YR
12
⬛ NOM%
6.17014
1780 +/– PMT
–1,780
25 × 12 = N
300
0 FV
0
PV
271,862.958902
Monthly payments of $1,780 over 25 years at an interest rate of j2 = 6.25% will repay a loan of $271,863, rounded.
Zeke Morris, a hobby farmer in Kamloops, and his partner, Betty Lou, have applied for a mortgage loan at the local bank. At the present time, there is a large supply of mortgage funds available. Rock Gilbraltar, a new employee of the bank, is asked to carry out the credit analysis for Zeke and Betty Lou’s mortgage loan application. Which of the following should Rock NOT consider in the credit analysis?
- The amount of Zeke’s personal loans
- Zeke and Betty Lou’s annual gross income
- The type of tractor that Zeke uses on his hobby farm
- The nature and the stability of Zeke’s sources of income
Correct Answer: 3
Option (3) is correct because Rock should NOT consider the type of tractor that Zeke uses on his hobby farm; it will not be included in the credit analysis. The other options should all be included in the credit analysis.
A prospective home buyer has applied for a mortgage loan to finance the purchase of a townhouse listed at $485,000. The market value of the townhouse is $475,000 and the lender has assigned a $472,000 lending value to it. The lender demands a 35% gross debt service ratio and an 80% loan-to-value ratio. The purchaser’s annual income is $90,000, property taxes are $2,200 per annum and, if approved, the loan is to be repaid with monthly payments over 20 years. The interest rate is 5.75% per annum, compounded semi-annually (j2 = 5.75%).
Calculate the maximum loan allowable under the lender’s loan-to-value criterion. Round your final answer to the nearest $100.
- $377,600
- $388,400
- $300,200
- $355,500
Correct Answer: 1
Option (1) is correct because the maximum loan allowable under the loan-to-value ratio is $377,600. The maximum loan under the loan-to-value ratio is 80% of the lending value. With a loan-to-value ratio of 80% and a lending value of $472,000, the maximum loan is $377,600.
0.8 × $472,000 = $377,600
A prospective home buyer has applied for a mortgage loan to finance the purchase of a townhouse listed at $485,000. The market value of the townhouse is $475,000 and the lender has assigned a $472,000 lending value to it. The lender demands a 35% gross debt service ratio and an 80% loan-to-value ratio. The purchaser’s annual income is $90,000, property taxes are $2,200 per annum and, if approved, the loan is to be repaid with monthly payments over 20 years. The interest rate is 5.75% per annum, compounded semi-annually (j2 = 5.75%).
Calculate the size of the monthly payment necessary to fully amortize the maximum loan amount based on the loan-to-value ratio (from the previous question).
- $2,935.51
- $2,636.50
- $2,381.02
- $2,464.22
Correct Answer: 2
Option (2) is correct because the monthly payment is $2,636.50. With a lending value of $377,600, the monthly payment is calculated as follows:
PRESS
DISPLAY
5.75 ⬛ NOM%
5.75
2 ⬛ P/YR
2
⬛ EFF%
5.832656
12 ⬛ P/YR
12
⬛ NOM%
5.682306
377600 PV
377,600
20 × 12 = N
240
0 FV
0
PMT
−2,636.495693
A prospective home buyer has applied for a mortgage loan to finance the purchase of a townhouse listed at $485,000. The market value of the townhouse is $475,000 and the lender has assigned a $472,000 lending value to it. The lender demands a 35% gross debt service ratio and an 80% loan-to-value ratio. The purchaser’s annual income is $90,000, property taxes are $2,200 per annum and, if approved, the loan is to be repaid with monthly payments over 20 years. The interest rate is 5.75% per annum, compounded semi-annually (j2 = 5.75%).
Assume that the monthly payments on the borrower’s loan are agreed to be $2,500. Calculate the minimum level of borrower’s income necessary to support these monthly payments based on the lender’s gross debt service ratio of 35%.
- $92,000
- $75,200
- $85,100
- $95,000
Correct Answer: 1
Option (1) is correct because the minimum income required is $92,000. Find the minimum borrower’s income necessary given the monthly payments of $2,500 and annual property taxes of $2,200.
Minimum income = PIT ÷ GDSR
Minimum income = [($2,500 × 12) + $2,200] ÷ 0.35
Minimum income = $32,200 ÷ 0.35
Minimum income = $92,000
In determining maximum allowable loans, a specific private mortgage lender accepts 100% of a household’s primary wage earner’s income plus 50% of the secondary wage earner’s income as the gross income for lending purposes. The lender has agreed to use a loan-to-value ratio of 75% and a GDSR of 35%. A lending value of $450,000 has been assigned to the property. The mortgage will be written at an interest rate of 6% per annum, compounded semi-annually, and will have monthly payments amortized over 20 years. Given that the primary wage earner’s income is $70,000 per annum, the secondary wage earner’s income is $40,000 per annum, and property taxes are $3,000 per annum, what is the maximum allowable loan? Round your final answer to the nearest dollar.
- $400,000
- $333,479
- $337,500
- $390,226
Correct Answer: 2
Option (2) is correct because the maximum loan that will satisfy both constraints is $333,479. The loan-to-value constraint results in a maximum loan of 0.75 × $450,000 = $337,500. The total income that will be used by the lender is $70,000 + (0.5 × $40,000) = $90,000. Multiply this income by the GDSR of 35% and subtract $3,000 in annual property taxes to give $28,500 as the maximum allowable annual mortgage payments, or $2,375 per month. Using this payment, an interest rate of j2 = 6%, and an amortization period of 20 years, the loan amount is calculated as follows:
PRESS
DISPLAY
6 ⬛ NOM%
6
2 ⬛ P/YR
2
⬛ EFF%
6.09
12 ⬛ P/YR
12
⬛ NOM%
5.926346
20 × 12 = N
240
2375 +/– PMT
–2,375
0 FV
0
PV
333,479.15527
The maximum loan that will satisfy both constraints is $333,479, rounded.
Queenie Spades and King Hearts have approached the Happy Trust Company to borrow $500,000 through a second mortgage secured by their office building. The outstanding first mortgage on this property was written 10 years ago for $725,000 at a rate of j2 = 7%. The loan called for level quarterly payments of $16,828.90, sufficient to amortize the principal over the loan term of 20 years. Annual net operating income for this building is $162,700.
The Happy Trust Company is willing to make a second mortgage loan at a rate of j4 = 9.5%. This loan requires quarterly payments sufficient to fully amortize the principal over a term of 10 years. The trust company requires a debt coverage ratio for the total of first and second mortgage payments of 1.2.
What size loan will Queenie and King qualify for, given the above conditions?
- Exactly $500,000
- Less than $500,000
- Greater than $500,000
- Cannot be determined from the information given
Correct Answer: 2
Option (2) is correct because Queenie and King will qualify for a loan less than $500,000. First, calculate the maximum debt service under the DCR. Then subtract the current total annual payments being made under the first mortgage loan. This will yield the funds available for the second mortgage loan. This can then be used to calculate the maximum second mortgage loan available.
PRESS
DISPLAY
162700 ÷ 1.2 =
135,583.333333
4 × 16828.9 =
67,315.60
+/− + 135583.33 =
68,267.73
÷ 4 =
17,066.9325
17066.93 +/− PMT
−17,066.93
9.5 I/YR
9.5
4 ⬛ P/YR
4
10 × 4 = N
40
0 FV
0
PV
437,588.890503
Queenie and King will qualify for a loan of $437,589, substantially less than $500,000.
Which one of the following statements is NOT one of the ways a mortgage broker can reduce the incidence of fraud?
- Verify borrowers’ identities
- Analyze documents for inconsistent details
- Forbid face to face interviews
- Verify that the appraisal is authorized by lender
Correct Answer: 3
Option (3) is correct because face to face interviews ARE one of the ways a mortgage broker can reduce the incidence of fraud. Options (1), (2), and (4) are incorrect because mortgage brokers can reduce the incidence of fraud by the following measures: analyzing documents for inconsistent details, requesting supporting documentation, verifying borrowers’ identities, conducting face to face interviews, maintaining proper documentation and records, and verifying that appraisal is authorized by lender.
A borrower has applied to XYZ Bank for a mortgage loan to finance the purchase of a $1,200,000 home in Vancouver. The bank has supplied the following information:
Lending Value:
$1,200,000
Loan-to-Value Ratio:
80%
Gross Debt Service Ratio:
39%
Amortization Period:
20 years
Payment Terms:
Monthly
Property Taxes:
$5,000 per year
Current mortgage rates are 5% per annum, compounded semi-annually and the government-specified qualifying rate is 5.25% per annum, compounded semi-annually. If the borrower’s annual gross income is $185,000 per year, what is the maximum loan, given the stress test borrower qualification rules for uninsured mortgages. Round your final answer to the nearest dollar.
- $601,730
- $960,000
- $727,382
- $892,116
Correct Answer: 3
Option (3) is correct because the maximum loan is $727,382 under the GDSR.
Loan-to-Value Ratio Constraint
Maximum Loan = Loan-to-Value Ratio × Lending Value
Maximum Loan = 0.80 × $1,200,000 = $960,000
Gross Debt Service Ratio Constraint
→
P + I = (0.39 × $185,000) − $5,000
P + I = $67,150 (annual mortgage payment)
Since the loan states that monthly payments are required:
Maximum monthly mortgage payment = $67,150 ÷ 12 = $5,595.83
The minimum qualifying rate is based on the greater of (1) the government-specified qualifying rate of j2 = 5.25% OR (2) an additional 2% above the mortgage’s negotiated contract rate. In this case, you would apply a rate of j2 = 7% (2% + 5%), which is greater than the government-specified rate of j2 = 5.25%. Monthly payments of $5,595.83 over 20 years at an interest rate of j2 = 7% will repay a loan of $727,382, rounded.
PRESS
DISPLAY
7 ⬛ NOM%
7
2 ⬛ P/YR
2
⬛ EFF%
7.1225
12 ⬛ P/YR
12
⬛ NOM%
6.900047
5595.83 +/− PMT
−5,595.82
20 × 12 = N
240
0 FV
0
PV
727,382.378337
Maximum loan amount using loan-to-value ratio constraint = $960,000
Maximum loan amount using gross debt service ratio constraint = $727,382
The maximum loan is the lesser of the amounts calculated under the loan-to value ratio and the gross debt service ratio, which is $727,382 under the GDSR constraint.
