California Real Estate Finance
Bond, McKenzie, Fesler & Boone
Ninth Edition
Chapter 9
Qualifying the Borrower
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Objectives
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After completing this chapter, you should be
able to:
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Discuss income requirements to qualify for different
types of loans.
Explain what effect debts have on a prospective
borrower’s qualifications.
Describe how lenders analyze stability of income.
Explain why lenders are concerned about borrowers’
credit history and credit score.
Draw up a list of things that real estate agents can do
to help clients to obtain financing.
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Outline
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How Lenders Qualify Prospective Borrowers
Ability or Capacity to Pay: A Case History
Capacity to Pay
Qualifying Under Government-Backed Loans
What is Income?
Co-Borrowing
After Income, What Then?
Desire to Pay
Working with Lenders
© 2011 Cengage Learning created by Dr. Richard S. Savich.
How Lenders Qualify
Prospective Borrowers
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Ability or capacity to pay
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Earn enough
Steady source
Enough cash
Other assets
Desire or willingness to pay
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Continue making payments?
Credit Score
Fannie Mae’s Desktop Underwriting
Freddie Mac’s Loan Prospector
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Ability or Capacity to Pay:
A Case History
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See Case on pp. 236-237.
Why qualify borrowers?
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Just take back house
Lenders are in money business,
not real estate business
High LTV ratios
Borrower could get “upside down”
If a loan is not sound for the
borrower, it is not sound for the
lender
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Capacity to Pay
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Income ratios
 Include PITI (FHA wants UFMIP & MMI also, Condos need HOA)
 < 33% of gross income (See next slide for calculations)
 But some go 45-50%
Compensating factors
 Substantial cushion/reserve
 Co-borrower
 Higher earnings potential
 Large down payment
 Currently making rent payments at same level
Debts
 Short term debts ignored
 Long term (10 months or longer to pay off)
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Includes alimony and child support
© 2011 Cengage Learning created by Dr. Richard S. Savich.
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Qualifying Under GovernmentBacked Loans (FHA)
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Same procedure as conventional lenders
Except front-end ratio <29%
And back-end ratio <41%
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Qualifying Under GovernmentBacked Loans (DVA)
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Residual Income Method
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Start with gross income
Subtract all taxes
To get Net Take-Home Pay
Subtract housing payment and
fixed obligations
Remainder is Residual Income
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See next slide for example Figure
9.3
Is this enough to provide for
the needs of the family?
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Family size
Geographic area
Price of home and neighborhood
Living pattern
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Income Ratio Application
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PITI
Long term debt
All divided by gross monthly
income
Should be < 41%
Compensating factors
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Down payment
No vehicle payments
Few credit cards
Substantial net worth
Stable work history
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Figure 9.3 Summary of
DVA qualifying procedure
Allowable gross income
$5,300
Less: Federal income tax
677
State income tax
172
Social Security or retirement
382
Net take-home pay
$4,069
Housing payment and fixed obligations
Principal and interest
$ 1,288
Property taxes
312
Homeowner’s insurance
66
Total mortgage payment
$1,666
Maintenance/utilities (@14 cents/sq. ft.)
Total housing expense
140
$1,806
Alimony and child support
0
Long-term debts
$ 375
Job-related expense
0
Total housing and fixed obligations
Analysis
$2,181
Net take-home pay
$4,069
Less: Housing and fixed expenses
Residual income
2,181
$1,888
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Qualifying Under GovernmentBacked Loans (Cal Vet)
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Adjusted Gross Income
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Remaining Income
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Gross income
Less federal and state income taxes
Less Social Security
Equals AGI
Less house payments (PITI plus maintenance and utilities)
Less long term debts (> 1 year to pay off)
Equals RI
RI/AGI = Residual
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Should be >50% of AGI
© 2011 Cengage Learning created by Dr. Richard S. Savich.
What is Income?
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Salaries
Commissions less expenses
Overtime (not usually)
Bonuses
Part-Time Work
Spousal/Alimony and Child Support
 Need not be revealed or questioned
 Payment can be questioned
Pensions and Social Security
Extra military pay (including free medical)
Income from real estate
Self-Employment
All these need at least two year history
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Co-Borrowing
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Co-mortgagors might help with income
Co-signers are on note, but not on title
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Lenders do not like this
© 2011 Cengage Learning created by Dr. Richard S. Savich.
After Income, What Then?
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Length of time on job
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Type of job
Age of borrower
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> 2 years
No longer a factor
Other assets
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Gifts from parents for down payment
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Supply “gift letter”
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Desire to Pay
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Past payment record
Bankruptcy
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Chapter 13 better than Chapter 7
Wait 3-4 years
Credit scores (Range from 300 - 900)
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720 required to get best loan terms and rates
Equifax
Experian
TransUnion
Affected by
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Late payments
Collections
Judgments
Write offs
Number of credit inquiries
Too many unused accounts
Under Federal Fair and Accurate Credit Transaction (FACT) Act, everyone is
entitled to a free copy of their credit report once a year
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Motivation
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Down payment
Reason for buying
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Working with Lenders
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Possibility
Honesty
Cooperation
Lender input
Government-backed loans
Exceptions and cover letters
See www.myfico.com for more information
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Questions and Comments?
© 2011 Cengage Learning created by Dr. Richard S. Savich.