Loan Origination Basics Flashcards
In its simplest terms, loan origination is the multi-step process through which a borrower obtains a mortgage loan from a lender.
That’s right. Loans are not created… they are originated. Truly, the words mean the same thing.
And loans are originated through the work of a mortgage loan originator.
The originator can be an institution or an individual that takes a borrower through a review process that will, hopefully, culminate in a loan agreement.
Mortgage Bankers and Mortgage Brokers
Two primary players in mortgage loan origination are mortgage bankers and mortgage brokers.
Mortgage bankers, also known as mortgage loan originators (MLOs) are companies, individuals, or financial institutions that create mortgages. They will either use their own funds or those from a warehouse lender to do this.
While mortgage bankers can retain and service the mortgages they create, generally, they do not. Their economic model is based almost exclusively on the revenue they generate from the fees associated with loan origination.
On the other hand, mortgage brokers, also known as mortgage loan brokers (MLBs), have zero money to lend.
Mortgage brokers are intermediaries. They broker the deal that brings lenders and borrowers together. They can save the borrower both money and time by lining them up with the lender best suited to address their particular situation.
Mortgage brokers receive their compensation from the lender in the form of an origination fee.
Your Role with Bankers and Brokers
You should expect that your clients will come to you for references of reputable mortgage bankers and mortgage brokers in the area. The more experience you have in the local market, the more likely you will be able to point clients to professionals that can help them. And when you’re just starting out, your broker will certainly be able to supply you with good references to share.
Any recommendations that you give a client can be independently verified by their own research.
Government Oversight
Because the process is fairly complex and often entails specialized information not always easily understood by the consumer, loan origination is overseen by governmental entities at both the federal and state level.
FDIC
On a federal level, the Federal Deposit Insurance Corporation (FDIC) looks out for the consumer’s interests in loan origination through the implementation of Title XIV of the Dodd-Frank Wall Street Reform and Consumer Protection Act. This act is something we revisit multiple times and in more detail elsewhere in this course.
Mortgage Loan Origination
Did you think Arizona was going to leave it to the feds to look out for the interests and needs of its citizenry? Not a chance, my friend.
Arizona Department of Financial Institutions
The Arizona Department of Financial Institutions (AZDFI) is statutorily charged with the licensing, supervision, and regulation of state-chartered financial institutions and enterprises. This includes mortgage bankers, mortgage brokers, loan originators, escrow agents, consumer lenders, and more.
Through this oversight, AZDFI ensures the safety and soundness of the financial services industry in Arizona.
The department also investigates complaints that are filed by consumers against licensed entities, and it directs appropriate remedial action if the violations are substantiated.
Arizona Revised Statutes
All of the work done by AZDFI is carried out in accordance with Arizona Revised Statutes Title 6, 32, and 44 as well as the Arizona Administrative Code Title 20, Chapter 4.
Many of these state laws reinforce the same rights given to consumers through various federal mandates.
For example…
Right of Rescission
Arizona Revised Statutes §6-906(D) and §6-946(E) reiterate the Federal Truth in Lending Act’s 3-day right of rescission that a borrower has on a refinance loan entered into with someone other than their primary lender. This right provides the borrower with time to reconsider the loan and back out and retrieve any monies they have paid out if they decide it’s not in their best interests.
Usury Laws
Usury laws prohibit lenders from charging borrowers excessively high rates of interest on loans. They are generally regulated and enforced at the state level. Most states have usury laws that set limits on interest rates.
Arizona’s usury law caps interest rates at 10%.
Arizona Efforts
The Steps to Loan Approval
The mortgage loan approval process breaks down into two or three steps, depending on the state you’re operating in.
Three-Step States
Most states use some variation of a three-step process that looks like this:
Step 1 - Pre-Qualification
A lender takes a prospective borrower at their word regarding the borrower’s financial and risk profile and then gives them a general estimate of the amount for which they could expect to be approved.
This is a v-e-e-e-r-y informal step that serves more to steer the buyer towards properties they could likely afford than it is to give assurances to sellers of a buyer’s financial qualifications.
Step 2 - Pre-Approval
A lender thoroughly reviews the borrower’s qualifications and, if the borrower is approved, offers a pre-approval letter indicating the borrower’s ability to obtain financing.
The borrower can use this form to give assurance to sellers of their ability to get financing.
Step 3 - Final Loan Approval
A lender makes a final analysis of the borrower’s creditworthiness and adds to that an evaluation of the property collateralizing the loan.
If the lender is comfortable with the risks involved, a mortgage (loan) commitment is made. This usually occurs after a purchase offer contract has been entered into.
Arizona Does the Two-Step
Maybe Arizona just likes getting things done a little faster; who knows? But when it comes to mortgage loan approvals, that’s certainly the case.
Here’s a brief view of the Arizona “two-step” process, which centers around the use of two forms. (I see you dancing, Anthony.) 🕺🏽
Step 1 - Pre-Qualification
The Arizona version of pre-qualification has more teeth to it as compared to other states.
In Arizona, the majority of brokerages use the Arizona Association of REALTORS® Pre-Qualification Form to assure sellers that a buyer has the ability to get financing for the property purchase.
The form is usually filled out after a buyer has consulted with a lender and provided whatever financial documentation they have, such as pay stubs, tax returns, and bank statements.
The Pre-Qualification Form is expected to be attached to any purchase offer a buyer makes.
Step 2 - Loan Status Update
At the time a purchase offer is made, the buyer commits to providing the seller with a second Arizona Association of REALTORS® form, known as the Loan Status Update Form, within 10 days of offer acceptance.
It will contain all of the same information as the Pre-Qualification Form and more, including information regarding the property being purchased and the underwriting activity that must take place prior to loan commitment and closing.
Additionally, the buyer will authorize the lender to provide updated versions of this form to the seller upon request (assuming a purchase offer has already been accepted).
Circle Back and Dig Deeper
Now that you have a surface-level understanding of the Arizona loan process, let’s circle back and look at the two steps a little more closely.
The Steps to Loan Approval
Pre-qualification is the first step in the Arizona loan application process. And, as mentioned previously, it typically involves the use of the Arizona Association of REALTORS® Pre-Qualification Form.
Pre-Form Footwork
But before we talk about the form, I want to back up a bit and discuss the interaction that tends to lead to its use.
When a buyer decides to become a buyer, they will have a general idea that they are in a position to purchase a property. The buyer will reach out to a real estate agent for representation and contact a lender to get a better idea as to “how much house” they can buy.
Sometimes the buyer already has a lender in mind or finds one on their own, but other times they look to their agent to assist them in finding a suitable lender.
One way or the other, in most cases, a buyer approaches the effort to purchase a property with an agent and a lender working alongside them.
The Form
If the agent working with the buyer is a REALTOR®, they’ll use that association’s Pre-Qualification Form as the starting point in the process — even before they spend any time showing properties to the buyer.
As the form’s title implies, it’s used to provide assurance to sellers that the buyer is qualified for a loan up to a certain amount.
The buyer will be instructed to meet with a lender and fill out the form, bringing a copy back to the agent for use if and when a desirable property is found.
“Chance Favors the Prepared Mind”
The above quote from Louis Pasteur comes to mind when thinking about the purpose of the Pre-Qualification Form.
In Arizona, sellers — and the agents who represent them — are conditioned to expect buyers to come to the proverbial table with proof of their ability to buy when they make offers on a property. Buyers with a pre-qualification form in tow will certainly be looked upon more favorably than those who show up empty-handed.
And, depending on how competitive the market is, a buyer can’t afford to wait until they find something they like before getting the form filled out. While Mr. Pasteur isn’t thought to have said, “Ya snooze, ya lose!” it’s true nonetheless. In the time it takes to meet with a lender to fill out the form, another more-prepared buyer can swoop in and take the property off the market.
More on the Form
Answer a couple of questions that follow this screen, and you’ll be rewarded with more details about the Pre-Qualification Form.
How’s that for incentive!
Step 1: Pre-Qualification
Nice job with those questions, Anthony!
As promised, here’s a little more detail on the pre-qualification form that is used in Arizona.
Attached to the Offer
Remember, that this form is usually filled out by the buyer/borrower and the lender prior to the buyer making an offer on a property. And when an offer is made, this form is attached to the purchase offer.
This action shows the seller:
Serious intent to buy
Ability to buy
Here’s Your Proof
To the second point above, the pre-qualification form contains the preliminary evidence that a buyer is financially able to purchase the property.
I say preliminary because the lender, at the point during which the form is filled out, does not have a complete financial picture or absolute verification of the buyer’s qualifications. But it is a snapshot of what they have gathered thus far.
Even if they have possession of a number of documents that lead the lender to pre-qualify the buyer, there is still underwriting to do.
This is why the pre-qualification form itself contains the following caveat:
This information does not constitute loan approval. All information provided must be approved by an underwriter, and any material change in Buyer’s credit or financial profile will render this pre-qualification null and void.
Here’s a partial list of the significant buyer financial information you might find on the pre-qualification form:
Lender information, including license numbers and signatures
Whether the purchase offer will be contingent on the sale or lease of another property
Whether the buyer is expecting seller concessions on closing costs
Loan type sought
Buyer expectations/need for down payment assistance
Whether the lender has possession of buyer financial documents, including credit reports, pay stubs, and tax forms
Pre-qualification approved loan amount
Expiration date of the pre-qualification form
Arizona Association of REALTORS® Pre-Qualification Form
With permission from our friends at the Arizona Association of REALTORS®, I present you with a copy of the Pre-Qualification Form to view at your leisure…
A blank “Pre-Qualification Form.”
Pre-Qualification: The Form
Whereas the Pre-Qualification Form is the document used in the first step of Arizona loan approval, the second step entails the use of the Loan Status Update — another form created by the Arizona Association of REALTORS®.
10 Days or Less
When the seller accepts the buyer’s purchase offer, a sales contract is signed by the parties. That contract will contain a paragraph committing the buyer to deliver the Loan Status Update to the seller within 10 days of contract acceptance.
Not only that, the buyer further instructs the lender to provide the seller (and listing broker) additional (current) update forms upon request.
Form Purpose
Again, the form’s purpose is pretty much spelled out in its name: Loan Status Update.
The form gives a current update of the loan approval status as of the moment the form is issued. Think of it as a financial snapshot… a progress report on the underwriting efforts the lender is going through to get to a point of loan commitment.
Given how fast the underwriting process goes these days, the very first update form the seller sees will actually be pretty accurate in terms of the buyer’s financial status and the likelihood of a loan’s approval.
Checkin’ It Twice (or More)
But, as you’ll see shortly, the update form contains a checklist of lender activities to be undertaken, right up until closing day. So, it does make sense that the seller and listing broker would want to see newer versions of the form, reflecting the progress that is being made on the loan application.
For more details on that, just answer a couple of questions before proceeding to the next page!
Step 2: Loan Status Update
In addition to the buyer information that you’ll find on the pre-qualification form, the update form provides a look at the following:
Closing Date
Names of parties to the sales contract
Subject property information
A documentation checklist of lender activities regarding such things as the Loan Estimate and disclosure forms, title commitment, rate lock, and property appraisal
Underwriting and loan approval progress
Closing preparation
Two Approvals in One
You may have noticed from the above checklist that the loan approval process involves not only an evaluation of the borrower but also the property being purchased (that’s what the appraisal work is all about).
In other words, there are two approvals that happen in conjunction with Step 2:
Borrower approval (creditworthiness of the borrower)
Property approval (value of the property)
Approval 1: The Borrower
A lender will keep their eye on a borrower right up until the day of closing. You wouldn’t believe some of the stories I could tell you about the things borrowers do in the 11th hour of the underwriting process that put their loan application in jeopardy.
That said, it is true that the bulk of the borrower evaluation has already been done during the pre-qualification step and by the time the first Loan Status Update form is delivered. What really goes on with respect to the borrower from that point forward is simply to make sure that nothing of significance has changed while the underwriting focus has shifted to the property.
And speaking of the property…
Approval 2: The Property
The evaluation of the property being financed is one of the biggest differences between Step 1 and Step 2 of the loan approval process.
Why do you suppose that lenders need to evaluate the property?
Well, the lender needs assurance that the value of the property is sufficient to serve as collateral for the loan. Otherwise, the lender could be at risk of taking a loss in the event of borrower default.
Loan Commitment
On the positive side, when both buyer and property approvals are complete, the loan can be approved and a loan commitment can be made. Even better, sometimes these commitments come with an opportunity for the borrower to lock in a favorable interest rate.
If the buyer locks in a rate, the seller will see that documented in the most current Loan Status Update form if they request one. While the seller won’t directly benefit from a borrower’s rate lock, they can take it as a good sign that the loan approval process is progressing nicely and that the buyer is happy with the terms of the proposed loan.
For Your Viewing Pleasure
Again, with permission from our friends at the Arizona Association of REALTORS®, I present you with a copy of the Loan Status Update form to view at your leisure…
A blank “Loan Status Update” contract.
Loan Status Update: The Form
Underwriting
How does a lender decide if they are satisfied with the borrower and the property?
Through a little process that I like to call underwriting. (Actually, most folks in the biz call it that.)
A Step 2 Activity
In the two steps of loan approval that we just covered, underwriting takes its rightful place during the second step. This occurs between the time a purchase contract is signed and the optimistically scheduled closing day.
To actually get to closing, however, a decision needs to be made to accept (via a loan commitment) or reject the prospective borrower.
Risk Tolerance
At its core, underwriting is the process of determining the level of risk a borrower presents to a lender.
It’s a complex endeavor that has been automated to some degree, but still requires the work of a specially trained professional, called an underwriter.
This evaluation is carried out using the information provided from the borrower’s loan application, bank balances, credit history, tax returns, and more.
Additionally, information about the property that will be collateralizing the loan will be gathered and analyzed. This is because property value also influences the degree of risk involved.
To make sure you catch this point, I’ll risk repeating myself: In order to determine whether or not to approve a loan, the underwriter needs to evaluate both the buyer AND the property.
Like it or not, Anthony, computers and robots are taking over the world. Well, the world of lending, anyway. (Don’t worry. If it ever goes beyond that, we’ll be benevolent dictators.)
Computerized Loan Origination
Computerized loan origination (CLO) refers to an electronic network of participating mortgage lenders. It gives brokers real-time interest rates and loan terms being offered by all of the lenders in the network.
From the comfort of your real estate brokerage office, large numbers of lenders can be accessed through a dedicated terminal and matched up to your clients’ particular needs.
It’s kinda like online dating without all the creepiness.
Once matched up, those lenders can use automated underwriting systems to evaluate loan applications.
RESPA Rules
A broker using a CLO network to match up a lender with a borrower can earn origination fees of up to one-half percent of the loan amount. That fee must be paid by the borrower and not the lender. This avoids violations of RESPA’s rules against kickbacks.
The origination fee will generally show up as a closing cost to be paid by the borrower and will often be financed into the loan.
Additionally, although multiple lenders can be found through the network, consumers must be informed that other lenders are available outside of the CLO system.
Person in a sunny room typing on a laptop.
Automated Underwriting
The primary method for making an underwriting decision these days is via something known as automated underwriting.
Through software programs, lenders are able to evaluate the borrower’s income, assets, liabilities, and debt-to-income ratios — all the criteria required to make a determination about the applicant.
Even the most complex of mortgages can usually be processed in less than 72 hours.
The computer models determine the borrower’s likelihood of defaulting on the mortgage loan. And they can also determine the amount of income, credit history, and other documentation that should be required by the lender.
Manual Underwriting May Be Required
If the computer rejects the borrower, the file goes to a live underwriter for manual review. The underwriter looks for any additional information or extenuating circumstances that would enable them to approve the buyer.
EXAMPLE
Marissa is a borrower whose loan application was rejected by a lender’s automated underwriting program. The primary cause for this was that her debt-to-income ratio did not meet the lender’s standard.
In rejecting Marissa’s application, the automated underwriting system also flagged her file for manual review by Samuel, a live underwriter.
When Samuel reached out to Marissa, she was able to provide him with documentation of a substantial personal retirement account that had not been considered in her evaluation.
Taking this new information into account, Samuel was able to approve Marissa’s loan.
That’s right, Anthony. As good as we are, we robots will always have need of the human touch!
Automation = Savings & Opportunity
Automated underwriting has lowered the cost of loan processing for lenders.
Just as importantly, it has created homeownership opportunities for borrowers who might not have been approved through traditional underwriting procedures.
HUD has encouraged the use of computerized loan origination systems because they believe that properly designed computer programs can standardize judgment and prevent bias.
It expedites the loan process and usually saves the borrower money.
CLO and Automated Underwriting
You remember Fannie Mae and Freddie Mac, don’t you?
They are players in the secondary mortgage market known as GSEs (government-sponsored enterprises) that buy up the mortgages originated by lenders on the primary mortgage market.
Because of their financial interest in these mortgages, they’d like to have some say in the underwriting that goes into the loan approval process.
To that end, Fannie and Freddie have each developed CLOs that participating lenders can use to automate their underwriting. Each system aligns with the specific underwriting guidelines of its GSE creator.
Desktop Underwriter by Fannie Mae
Fannie Mae encourages lenders to use its automated electronic underwriting system, Desktop Underwriter (DU). This tool is designed to reduce the time and cost involved in underwriting.
The system uses pre-programmed information and formulas to conduct a quantitative risk analysis, taking away human bias. The result is based on the information the lender provides along with credit history pulled from the three large credit bureaus: Equifax, TransUnion, and Experian.
This allows the lender to complete a web version of the Uniform Residential Loan Application, or to fill out a “Quick 1003” using a smaller set of data for a quick recommendation.
Say “No” to FICO
DU does not use FICO credit scores in its analysis. Since the technology that produces these scores is owned by Fair Isaac and Co., Fannie Mae cannot use them in compliance with its stated goal of informing applicants why their applications are accepted or rejected. Nevertheless, Fannie Mae encourages lenders to make use of FICO scores in evaluating an applicant’s credit.
Loan Prospector by Freddie Mac
Freddie Mac’s Loan Prospector (LP) is the equivalent of Fannie Mae’s Desktop Underwriter. Lenders enter the same borrower information, and the system determines whether the loan is an:
“Accept”
“A-minus caution”
“Manual underwrite loan”
As you can see, the system does NOT reject a loan, rather, it refers the application to a manual underwriter.
RESPA Deserves Your Respect-a
Whether we’re talking about Fannie Mae’s DU, Freddie Mac’s Loan Prospector, or another computerized loan origination system altogether, automated underwriting should always be careful to follow RESPA and other federal guidelines and regulations.
Fannie & Freddie Do CLOs
Chapter 1 covered lots of good info, Anthony. Let’s do a quick review of some of the important terms, concepts, and principles you’ve learned along the way.
Key Terms
loan commitment
a lender’s approval of a specific loan for a specific property; occurs upon completion of final loan approval step
loan origination
the process through which a buyer obtains a mortgage loan from a lender
underwriting
the process of determining the level of risk a lender is willing to take in extending a loan to a borrower
Key Concepts & Principles
Here are the concepts and principles you’ll want to master from this chapter:
Mortgage Loan Origination
In its simplest terms, loan origination is the multi-step process through which a borrower obtains a mortgage loan from a lender.
The originator can be an institution or an individual.
Mortgage bankers are companies, individuals, or financial institutions that create mortgages. They will either use their own funds or those from a warehouse lender to do this.
Mortgage brokers have zero money to lend. They are intermediaries that bring lenders and borrowers together.
Arizona Department of Financial Institutions
The Arizona Department of Financial Institutions (AZDFI) is statutorily charged with the licensing, supervision, and regulation of state-chartered financial institutions and enterprises.
Two Steps to Loan Approval
Step 1 - Pre-Qualification
In Arizona, the majority of brokerages use the Arizona Association of REALTORS® Pre-Qualification Form to assure sellers that a buyer has the ability to get financing for the property purchase.
The form is usually filled out after a buyer has consulted with a lender and provided whatever financial documentation they have.
Examples of the information a borrower might provide:
Pay stubs
Tax returns
Bank statements
The Pre-Qualification Form is expected to be attached to any purchase offer a buyer makes.
Step 2 - Loan Status Update
At the time a purchase offer is made, the buyer commits to providing the seller with a second Arizona Association of REALTORS® form, known as the Loan Status Update Form.
This must be given to the seller within 10 days of offer acceptance.
It will contain all of the same information as the Pre-Qualification Form and more. This includes property information and a checklist documenting underwriting activity.
The buyer will authorize the lender to provide updated versions of this form to the seller upon request.
Table of the Arizona loan approval forms detailing what is part of the pre-qualification form and what is part of the loan status update form.
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Underwriting
At its core, underwriting is the process of determining the level of risk a borrower presents to a lender.
In order to determine whether or not to approve a loan, the underwriter needs to evaluate both the buyer AND the property.
Computerized Loan Origination
Computerized loan origination (CLO) refers to an electronic network brokers use to match participating mortgage lenders to their clients’ particular needs.
Automated Underwriting
The primary method for evaluating loan applicants is via sophisticated software programs rather than live underwriters.
These computer models can determine a borrower’s likelihood of defaulting on the mortgage loan. They can also determine the amount of income, credit history, and other documentation that should be required by the lender.
The benefits of automated underwriting are:
Efficiency
Cost
Lack of Bias
Chapter Summary
