Mortgage Underwriting Flashcards
What Is a Conforming Loan?
A conforming loan is a mortgage that is equal to or less than the dollar amount established by the limit set by the Federal Housing Finance Agency (FHFA) and meets the funding criteria of Freddie Mac and Fannie Mae.
For borrowers with excellent credit, conforming loans are advantageous due to the low-interest rates affixed to them.
Fannie Mae and Freddie Mac
- Federally backed home mortgage companies created by the U.S. Congress.
- Neither institution originates or services its own mortgages.
- Instead, they buy and guarantee mortgages issued through lenders in the secondary mortgage market.
Conforming Loan
4 KEY TAKEAWAYS
A conforming loan is a mortgage whose underlying terms and conditions meet the funding criteria of Fannie Mae and Freddie Mac—mainly, a dollar limit on the size of the loan.
The baseline conforming loan limit is adjusted annually. It is $548,250 in 2021 for most parts of the U.S.
Lenders prefer to deal with conforming loans, as these are the only type that Fannie Mae and Freddie Mac will guarantee and buy in the secondary mortgage market.
Conforming loans often offer more advantageous rates for borrowers.
What Is a Nonconforming Mortgage?
A nonconforming mortgage is a mortgage that does not meet the guidelines of government-sponsored enterprises (GSE) such as Fannie Mae and Freddie Mac and, therefore, cannot be sold to them.
GSE guidelines consist of a maximum loan amount, suitable properties, down payment requirements, and credit requirements, among other factors.
Nonconforming Mortgage
Key Takeaways
A nonconforming mortgage is a home loan that does not adhere to government-sponsored enterprises (GSE) guidelines and, therefore, cannot be resold to agencies such as Fannie Mae or Freddie Mac.
These loans often carry higher interest rates than conforming mortgages.
Mortgages that exceed the conforming loan limit are classified as nonconforming, and are called jumbo mortgages.
Other than the loan size, mortgages may become nonconforming based on a borrower’s loan-to-value ratio (down payment size), debt-to-income ratio, credit score and history, and documentation requirements.
What Is a Conventional Mortgage or Loan?
A conventional mortgage or conventional loan is any type of home buyer’s loan that is not offered or secured by a government entity. Instead, conventional mortgages are available through private lenders, such as banks, credit unions, and mortgage companies.
However, some conventional mortgages can be guaranteed by two government-sponsored enterprises; the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).1
Conventional Mortgage or Loan
Key Takeaways
KEY TAKEAWAYS
A conventional mortgage or conventional loan is a home buyer’s loan that is not offered or secured by a government entity.
It is available through or guaranteed by a private lender or the two government-sponsored enterprises—Fannie Mae and Freddie Mac.
Potential borrowers need to complete an official mortgage application, supply required documents, credit history, and current credit score.
Conventional loan interest rates tend to be higher than those of government-backed mortgages, such as FHA loans.
Conventional vs. Conforming
Conventional loans are often erroneously referred to as conforming mortgages or loans. While there is overlap, the two are distinct categories. A conforming mortgage is one whose underlying terms and conditions meet the funding criteria of Fannie Mae and Freddie Mac. Chief among those is a dollar limit, set annually by the Federal Housing Finance Agency (FHFA). In most of the continental U.S., a loan must not exceed $548,250 in 2021.4
So while all conforming loans are conventional, not all conventional loans qualify as conforming. A jumbo mortgage of $800,000, for example, is a conventional mortgage but not a conforming mortgage—because it surpasses the amount that would allow it to be backed by Fannie Mae or Freddie Mac.1
In 2020, there were 8.3 million homeowners with FHA-insured mortgages.5 The secondary market for conventional mortgages is extremely large and liquid. Most conventional mortgages are packaged into pass-through mortgage-backed securities, which trade in a well-established forward market known as the mortgage to be announced (TBA) market. Many of these conventional pass-through securities are further securitized into collateralized mortgage obligations (CMOs).
Understanding Nonconforming Mortgages
Nonconforming mortgages are not bad loans in the sense that they are risky or overly complex. Financial institutions dislike them because they do not conform to GSE guidelines and, as a result, are harder to sell. For this reason, banks will usually command a higher interest rate on a nonconforming loan.
Although private banks initially write most mortgages, they often end up in the portfolios of Fannie Mae and Freddie Mac. These two GSEs buy loans from banks and then package them into mortgage-backed securities (MBS) which sell on the secondary market. An MBS is a type of asset-backed security (ABS) secured by a collection of mortgages that originated from a regulated and authorized financial institution. While there are private financial companies who will buy, package, and resell an MBS, Fannie and Freddie are the two largest purchasers.
Banks use the money from the sales of mortgages to invest in offering new loans, at the current interest rate. But Fannie Mae and Freddie Mac can’t buy just any mortgage product. The two GSEs have federal rules limits to buying loans that are deemed relatively risk-free. These loans are conforming mortgages, and banks like them precisely because they will readily sell.
By contrast, mortgages that Fannie Mae and Freddie Mac cannot buy are inherently riskier for banks to write. These difficult-to-sell loans must either stay in the bank’s portfolio or be sold to entities specializing in the secondary market for nonconforming loans.
What is a Non-Qualified Mortgage (Non-QM)?
A non-qualified mortgage (non-QM) is a home loan designed to help homebuyers who can’t meet the strict criteria of a qualifying mortgage. For example, if you are self-employed or don’t have all the necessary documentation to qualify for a traditional mortgage, you might need to look at non-qualified mortgages.
A Qualified Mortgage (QM):
To qualify for a traditional mortgage, you must meet these requirements:
Income: You must have verifiable income, including pay stubs, W-2s, and tax returns.
Debt: Your debt-to-income ratio (DTI) must be 43% or less. This is the amount of your monthly income that goes toward your existing debts.
Limits on fees: Points and fees on your loan cannot exceed 3% of the loan amount.
No risky loan features: Risky features include interest-only loans (where you only pay interest without reducing the principal), negative amortization (where your principal can increase, even while you are making payments), or balloon payments (where a larger payment can be tacked on to the end of the loan).
Loan term: The loan term must be 30 years or less.
What Is a Jumbo Loan?
A jumbo loan, also known as a jumbo mortgage, is a type of financing that exceeds the limits set by the Federal Housing Finance Agency (FHFA). Unlike conventional mortgages, a jumbo loan is not eligible to be purchased, guaranteed, or securitized by Fannie Mae or Freddie Mac. Designed to finance luxury properties and homes in highly competitive local real estate markets, jumbo mortgages come with unique underwriting requirements and tax implications. These kinds of mortgages have gained traction as the housing market continues to recover following the Great Recession.
The value of a jumbo mortgage varies by state—and even county. The FHFA sets the conforming loan limit size for different areas on an annual basis, though it changes infrequently. As of 2019, the limit was set at $484,350 for most of the country. That was increased from $453,100 in 2018. For counties that have higher home values, the baseline limit is set at $726,525, or 150% of $484,350.
The FHFA has a different set of provisions for areas outside of the continental United States for loan limit calculations. As a result, the baseline limit for a jumbo loan in Alaska, Guam, Hawaii, and the U.S. Virgin Islands as of 2019 is also $726,525. That amount may actually be even higher in counties that have higher home values.
Jumbo Loan
Key Takeaways
A jumbo loan is a type of financing that exceeds the limits set by the Federal Housing Finance Agency and cannot be purchased, guaranteed, or securitized by Fannie Mae or Freddie Mac.
Homeowners must undergo more rigorous credit requirements than those applying for a conventional loan.
Approval requires a stellar credit score and a very low debt-to-income ratio.
The average APR for a jumbo mortgage is often par with conventional mortgages, while down payments are roughly 10% to 15% of the total purchase price.
How a Jumbo Loan Works
If you have your sights set on a home that costs close to half a million dollars or more—and you don’t have that much sitting in a bank account—you’re probably going to need a jumbo mortgage. And if you’re trying to land one, you’ll face much more rigorous credit requirements than homeowners applying for a conventional loan. That’s because jumbo loans carry more credit risk for the lender since there is no guarantee by Fannie Mae or Freddie Mac. There’s also more risk because more money is involved.
Just like traditional mortgages, minimum requirements for a jumbo have become increasingly stringent since 2008. To get approved, you’ll need a stellar credit score—700 or above—and a very low debt-to-income (DTI) ratio. The DTI should be under 43% and preferably closer to 36%. Although they are nonconforming mortgages, jumbos still must fall within the guidelines of what the Consumer Financial Protection Bureau considers a “qualified mortgage”—a lending system with standardized terms and rules, such as the 43% DTI.
You’ll need to prove you have accessible cash on hand to cover your payments, which are likely to be very high if you opt for a standard 30-year fixed-rate mortgage. Specific income levels and reserves depend on the size of the overall loan, but all borrowers need 30 days of pay stubs and W2 tax forms stretching back two years. If you’re self-employed, the income requirements are greater: Two years of tax returns and at least 60 days of current bank statements. The borrower also needs provable liquid assets to qualify and cash reserves equal to six months of the mortgage payments. And all applicants have to show proper documentation on all other loans held and proof of ownership of non-liquid assets (like other real estate).
Jumbo Loan Rates
While jumbo mortgages used to carry higher interest rates than conventional mortgages, the gap has been closing in recent years. Today, the average annual percentage rate (APR) for a jumbo mortgage is often par with conventional mortgages—and in some cases, actually lower. As of March 2019, Wells Fargo, for example, charged an APR of 4.092% on a 30-year fixed-rate conforming loan and 3.793% for the same term on a jumbo loan.
Even though the government-sponsored enterprises can’t handle them, jumbo loans are often securitized by other financial institutions; since these securities carry more risk, they trade at a yield premium to conventional securitized mortgages. However, this spread has been reduced with the interest rate of the loans themselves.
Down Payment on a Jumbo Loan
Fortunately, down payment requirements have loosened over the same time period. In the past, jumbo mortgage lenders often required home buyers to put up 30% of the residence’s purchase price (compared to 20% for conventional mortgages). Now, that figure has fallen as low as 10% to 15%. As with any mortgage, there can be various advantages to making a higher down payment—among them, to avoid the cost of the private mortgage insurance lenders require for down payments below 20%.
Jumbo vs. Conventional Mortgages
Jumbo and conventional mortgages are two types of financing used by borrowers to purchase homes. Both require homeowners to meet certain eligibility requirements including minimum credit scores, income thresholds, repayment ability, as well as minimum down payment requirements. Government-sponsored enterprises (GSEs), such as Fannie Mae and Freddie Mac, the Federal Housing Administration (FHA), the U.S. Department of Veterans Affairs (VA), or the USDA Rural Housing Service do not back either mortgage product. While they may be used for the same purpose—to secure a property—they are inherently different.
Jumbo mortgages are used to purchase properties with steep price tags—often those that run into the millions of dollars. Conventional mortgages, on the other hand, are more in line with the needs of the average homebuyer and can be conforming or nonconforming.1 Keep reading to find out more about these two kinds of mortgage products.
Jumbo Key Takeaways
Jumbo and conventional mortgages are two products borrowers use to secure properties.
Conventional mortgages can either conform to government guidelines or they can be non-conforming.
Jumbo mortgages tend to fall outside conforming loan restrictions, typically because they exceed the maximum amount backed by government-sponsored enterprises like Fannie Mae or Freddie Mac.
(FHFA)
Federal Housing Finance Agency
A Qualified Home Loan:
is one that complies with the requirements set forth by the Consumer Financial Protection Bureau (CFPB) and standards set by the federal government.
A Qualified Mortgage is:
A type of home loan that has stable features that make it likely that borrowers will be able to afford their loan. This mitigates much of the risk for lenders, which is why they tend to push for this type of home loan.
A Non-Qualified Mortgage (Non-QM) is:
A type of loan that doesn’t meet the traditional standards of a qualified mortgage. It uses non-traditional methods to verify your income so that a borrower can get approved for a home loan depending on their unique situation.
Non-QM loans can help those who are self-employed, have non-traditional or seasonal income, or have difficulty qualifying for a traditional mortgage loan. It may also be the best solution for those with past credit issues.
Non-QM loans have guidelines that allow the lender to see your financial history very thoroughly before making a decision about whether or not to approve your loan.
QM vs Non-QM Loans:
- A borrower taking a loan that will be bought by Fannie Mae or Freddie Mac provides pay stubs, tax returns and bank statements as part of the approval process. A non-QM borrower, on the other hand, typically submits only bank statements.
2.
What are non-QM loans?
Non-QM loans don’t meet the requirements set by the Consumer Financial Protection Bureau (CFPB) to be considered qualified mortgages. That means they don’t satisfy one or more of the following requirements:
The points and fees for loan amounts of $100,000 or more are less than or equal to 3%
The loan cannot have risky features like negative amortization, interest-only payments or a balloon payment
The term of the loan must be 30 years or less
The debt-to-income (DTI) ratio must be 43% or less
One important note: Non-QM loans are not like subprime loans from the last housing crisis. Lenders are still required to make a good-faith effort to verify you can repay the loan. However, non-QM lenders can create their own guidelines to prove you can afford the monthly mortgage payments.
Non-QM lenders offer more loan options for:
BORROWERS WHO ARE SELF-EMPLOYED
Instead of tax returns, non-QM lenders offer bank statement mortgage loans. With 12 to 24 months’ worth of personal or business statements, the lender evaluates deposits to determine your qualifying income.
BORROWERS WITH HIGH NET-WORTH
Some lenders offer asset depletion programs. By dividing your total cash balance by a lender-chosen time period, the asset is counted as income. For example, a $200,000 savings balance may be converted into $833.33 of extra monthly qualifying income with a typical 20-year asset depletion loan term.
BORROWERS INVESTING IN MULTIPLE RENTAL UNITS
Non-QM loans come in handy if you’re building a portfolio of investment properties but already own 10 mortgaged properties — the limit for most conventional lenders. Some lenders also offer debt-service coverage ratio loans for real estate investors. If the rent on the new home covers the monthly payment, you won’t need to verify any other income to qualify.
BORROWERS WITH RECENT BAD CREDIT
You may qualify for a non-QM loan one day after completing a bankruptcy or foreclosure. For standard loan programs, you typically need to wait two to seven years after a significant credit event.
BORROWERS WHO ARE FOREIGN NATIONALS
A foreign national is a citizen of another country who lives in the U.S. for brief periods for work or vacation. Non-QM loans for foreign nationals may not require proof of U.S. income, credit or a Social Security number.
BORROWERS WHO WANT AN INTEREST-ONLY PAYMENT OPTION
If your income is sporadic, an interest-only loan gives you a lower payment option during times of the year when you earn less. Qualified mortgage rules prohibit them, and with good reason: Your payment could increase after the interest-only period ends, making the loan harder to repay.
CFPB:
Consumer Financial Protection Bureau
Understanding non-QM underwriting guidelines
While there are no uniform underwriting standards for non-QM loans, lenders tend to specialize in certain types of non-QM products. Interest rates and loan terms may vary widely from lender to lender. Data compiled by CoreLogic in 2019 found the following common credit characteristics of closed non-QM loans:
The average credit score was 760
The average down payment was 21%
The average DTI ratio for non-QM homebuyers was higher in contrast to the DTI ratio for QM homebuyers
Moreover, CoreLogic’s analysis revealed the top three reasons borrowers choose a non-QM loan:
More flexible documentation requirements
More lenient DTI ratio limits
Option to choose interest-only payments
What is a mortgage bank?
A mortgage bank, also called a mortgage lender or even “lender” for short, is a financial institution with direct access to the money you need for your mortgage. Typically, the money comes from the company’s own bank account or from its investors.
How mortgage banks work
A lender can approve your loan application and provide money to you directly.
You’ll usually make your payments directly to the mortgage bank after your loan closing.
Mortgage banks only offer home loans — you won’t find options for checking accounts, credit cards or car loans.
Mortgage processors and underwriters work for the lender. Closing and funding of the loan is handled internally.
Documents can be uploaded to one central processing site.
What is a mortgage broker?
A mortgage broker has indirect access to the money for your home loan based on approved relationships with a number of different banks. A mortgage broker matches your finances with a mortgage bank that can fund your loan but doesn’t lend you the money directly.
How mortgage brokers work
The only paperwork in the broker’s name is your initial application.
You don’t typically find out which mortgage bank will fund your loan until you get your initial loan disclosures.
Processing may be done by an employee of the mortgage broker.
The rest of the process — from underwriting to closing and funding — is completed by the mortgage bank.
A separate company may prepare loan disclosures or closing documents.
What is a retail bank?
Many national and local retail banks and credit unions offer mortgages at their branches. While you might think of your bank as the place you deposit your paycheck, there’s a good chance they also offer a variety of home loan products.
How banks work
The money for the mortgage is with the bank.
The bank can fund the loan from its mortgage banking department.
The bank approves your loan and provides the money to you directly.
You may even get a special discount on closing costs if you pay your mortgage payment from a bank checking account.
Pros and Cons:
A Mortgage Bank
Pros
A mortgage bank:
May offer special proprietary loan products or down payment assistance
Has decision-making authority for special circumstances
Approves and funds in-house, and can make exception approvals
Cons
A mortgage bank:
Doesn’t offer any other financial products like checking or savings accounts
Can’t offer interest rate discounts based on your deposit balances because they don’t offer deposit accounts
Can’t switch you to a different lender if your loan is denied
Pros and Cons:
A Mortgage Broker
Pros
A mortgage broker:
Has access to more banks and programs
Can switch you to a different bank or lender if your loan is denied
Can shop for the most competitive rates with different lenders on your behalf
Cons
A mortgage broker:
Relies on other lenders to make the final loan decision
Can’t make exception decisions for difficult loan applications
Doesn’t fund the loan, which may create delays in closing
Pros and Cons:
A Bank
Pros
A bank:
May offer you lower rates based on your deposit balances
Has decision-making authority for special circumstances based on your banking history
Processes, approves and funds the loan in-house
Cons
A bank:
May not offer a wide variety of home loan products
Can’t switch you to another bank if your loan is denied
May set stricter minimum mortgage requirements that make loan approval more difficult
Bond and Down Payment Assistance (DPA) programs
Bond and Down Payment Assistance (DPA) programs are designed with one thing in mind, helping qualified homebuyers with the cost of purchasing a new home by providing grants or favorable terms on a second mortgage.
Is It Right for You?
A great option for first-time homebuyers or individuals who don’t have enough money set aside for a down payment or closing costs.
Is It Right for Your Situation?
Primary residence, single family and 2-4 unit properties, condos, and Planned Unit Developments (PUDs); maximum loan or grant amount varies by program selected.
Features and Benefits
Variety of down payment assistance options available
Second mortgages offered with preferred rates and flexible requirements
Grants are not required to be repaid
Tax credits may be available for eligible homebuyers
Program details, terms and income limits will vary
Can be used with a variety of conventional and government loan programs
Whether you are tired of renting or it’s time to find the home where you will begin raising a family, saving enough money for a down payment isn’t necessarily where your dream of homeownership ends. Gateway has a long list of relationships with local, county and state housing authorities which means owning a home of your own may be closer than you think.
