Lender Loan Process: Workshop

Question 1

Points represent prepaid interest, and the lender charges them to get additional income on the loan. Points are paid at closing and are usually equal to

Answer 1

1 percent of the loan amount.

Two (2) points on a $75,000 loan would be $1,500.
$75,000 x .01 x 2 points

Question 2

Discount points are a means of raising the effective interest rate of the loan.

Answer 2

The rule of thumb is 1/8 percent for each discount point. So a charge of 4 points would increase a 7.25 percent mortgage to a 7.75 percent yield.

4 points x 1/8 percent = 4/8 = .50 percent
7.25 + .50 = 7.75 percent

Question 3

Laura is getting an $85,000 loan at 7 percent and will pay 3 origination points. What will the point cost be and what will the effective interest rate be?

Answer 3

Point cost: $2,550
$85,000 x .01 x 3 points
Effective interest rate: 7 percent (Origination points do not change the effective rate of the interest.)

Question 4

Bill and Jenna are getting a $175,000 loan at 8 percent and will pay 4 discount points. What will the point cost be and what will the effective interest rate be?

Answer 4

Point cost: $7,000
$175,000 x .01 x 4 points   
Effective interest rate: 8.5 percent
4 points x 1/8 percent = 4/8 = .50 percent 
8.0 + .50 = 8.5 percent

Question 5

Hal is getting a $65,000 loan at 9 percent and will pay 2 discount points. What will the point cost be and what will the effective interest rate be?

Answer 5

Point cost: $1,300
$65,000 x .01 x 2 points    
Effective interest rate: 9.25 percent
2 points x 1/8 percent = 2/8 = .25 percent 
9.0 + .25 = 9.25 percent

Question 6

Neil and Jennifer will get a $285,000 loan at 7.5 percent and will pay 1 origination point and 2 discount points. What will the point cost be and what will the effective interest rate be?

Answer 6

Point cost: $8,550
$285,000 x .01 x 3 points (They are paying 3 total points.)
Effective interest rate: 7.75 percent
2 points x 1/8 percent = 2/8 = .25 percent (Only 2 of the 3 points are discount points.)
7.5 + .25 = 7.75 percent

Question 7

let’s see how the lender allocates the interest and principal.

Answer 7

Loan is $90,000
Rate is 5.75 percent per year
Monthly payment is $525.22
$90,000 x .0575 = $5,175 yearly interest due
$5,175 ÷ 12 = $431.25 first month’s interest
$525.22 - $431.25 = $93.97 first month’s principal
Now the lender will subtract the principal payment from the initial loan balance to arrive at the loan balance for next month’s calculation.

$90,000 - $93.97 = $89,906.03

Question 8

Here’s the calculation for the third month of Julie and Bob’s mortgage.

Answer 8

Current loan balance $89,811.61
Rate is 5.75 percent per year
Monthly payment is $525.22
$89,811.61 x .0575 = $5,164.17 yearly interest
$5,164.17 ÷ 12 = $430.35 third month’s interest
$525.22 - $430.35 = $94.87 third month’s principal
New balance for next month’s calculation.

$89,811.61 - $94.87 = $89,716.74

Question 9

Gary and Sue want to purchase a home for $92,000. Here are the facts, along with how the lender will calculate the income ratio.

Answer 9

Total amount of new house payment: $900.00

Gary and Sue’s gross monthly income: $4,000.00

Divide total house payment by gross monthly income:

$900 ÷ $4,000

Income ratio: 22.5%

Question 10

Now here’s how the lender will calculate the debt ratio.

Answer 10

Total amount of new house payment:$900.00

Total amount of monthly recurring debt: $725.00

Total amount of monthly debt: $1,625.00

Gary and Sue’s gross monthly income: $4,000.00

Divide total monthly debt by gross monthly income:

$1,625÷$4,000

Debt ratio: 40.62%

Question 11

The 12 month/360 day method

Answer 11

calculates the amounts due based on a 360-day year and a 30-day month. The steps of this method are as follows.

Question 12

The 365-day method calculates the amounts on the basis of a 365-day year.

Answer 12

1. Identify an item and the amount needing to be prorated.
2. Divide by 365 to get the daily rate. (Divide by 366 in a leap year.)
3. Multiply the daily rate by the number of days the seller owned the property before closing to get the seller’s share.
4. Subtract the seller’s prorated amount from the starting amount to get the buyer’s prorated amount.

Question 13

Break-even Analysis

Answer 13

Break-even analysis is the chief method used to estimate the potential profitability of a real estate investment. This involves determining the investment’s break-even point, which is the point at which the gross income is equal to a total of the fixed costs, plus all of the variable costs that were incurred to generate the gross income.

Question 14

Break-even point is calculated using this formula:

Answer 14

Break-even = Fixed costs ÷ (1- Variable cost ratio)

Question 15

Lenders estimate an income property’s value from its capitalization rate using the following formula:

Answer 15

Value = income ÷ rate

Question 16

Keep in mind that the formula above can be rearranged to find any of the values, if the other two are known. Here are the other two formulas.

Answer 16

Rate = Income ÷ Value 
Rate = $50,000 ÷ $500,000 
Rate = 10 percent 
Income = Value x Rate 
Income = $500,000 x .10 
Income = $50,000

Question 17

From a buyer’s perspective, interest can be defined as

Answer 17

the amount paid in return for the use of money. From the lender’s perspective, interest is money earned or received from a loan investment.

Question 18

Simple interest is

Answer 18

money that is paid only for the amount of principal the borrower still owes.

Question 19

Compound interest is defined as

Answer 19

interest which is computed on the principal amount plus the accrued interest.

Question 20

Points are

Answer 20

a one-time service charge to the borrower for making the loan. There are two types of points:

Origination points
Discount points

Question 21

Borrowers are responsible for making monthly mortgage payments, which include both principal and interest

Answer 21

The lender runs an amortization schedule that is based on the amount of the loan, the term of the loan and the interest rate. Most real estate mortgage loans are based on simple interest.

Question 22

Lenders will try to estimate a potential borrower’s ability to fulfill the loan obligation by establishing an income ratio and a debt ratio

Answer 22

Conventional loans typically require the income ratio to be under 28 percent and the debt ratio to be 36 percent or lower. FHA guidelines require the income ratio to be no more than 31 percent and the debt ratio no more than 43 percent.

Question 23

Some expenses paid at closing must be prorated or divided proportionately between the buyer and the seller

Answer 23

Any item that is prorated is shown on the settlement statement as a debit to one party and a credit to the other party for the same amount.

Question 24

Closing agents and lenders typically use one of two methods when calculating items that need to be prorated

Answer 24

the 12- month/360-day method and the 365-day method.

Question 25

When deciding to make a commercial loan, a lender will thoroughly examine the borrower’s financial liquidity and assess the profitability of the specific project

Answer 25

The loan analyst will be most interested in the project’s break-even point and its return on investment (ROI).

Question 26

The breakeven point is

Answer 26

the point at which the gross income is equal to a total of the fixed costs, plus all of the variable costs that were incurred to generate the gross income.

Question 27

The return on investment is the

Answer 27

ratio of pre-tax net income to the money invested. Real estate lenders often use a required return on an investment, called a capitalization rate, as the means for estimating the value of the collateral being pledged for a loan.