Residential Loan Underwriting
Baruch College: RES3200
“As long as the music is playing, you've got to get up
and dance."
Chuck Prince, Citi CEO, 2003-2007
1
Baruch College: RES3200
RES-3200
2
 Intro
 ARM
 Commercial RE
 Legal
 Refinance
 Finance
 Underwriting
 FRM
 Buy vs Lease

 Exam 1
 Exam 2
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




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Baruch College: RES3200
Pro Forma
 Underwriting
Cap rates
Leverage
Risk
Development
Ownership Entity
MBS (MPT, CMO)
REIT
Portfolio
Exam 3

Residential Loan Underwriting
Roadmap
3
 What is underwriting? Who is an underwriter?
 3 C’s of underwriting: Credit, Capacity, Collateral
 Default insurance: Government (tax-payer) insurance vs PMI
 Types: conventional, FHA\VA, Jumbo, Subprime
 Loan Level Price Adjustment (LLPA)
 Underwriting Example
 Loan Modifications
 Rental Underwriting
Baruch College: RES3200
Residential Loan Underwriting
What is Loan Underwriting?
4
 Loan Underwriting the process by which a lender evaluates the eligibility of a
borrower to receive a loan.
 Players:



Loan Officer (Mortgage Broker): “sells” the loan.
Loan Underwriter: assesses (“underwrites”) the loan.
Loan Servicer: collects pmt from borrower, remits to lender, taxes and insurance into escrow account etc.

Collect late fees, make advance payments…
 The underwriter assesses the risk of loss when deciding to lend
 Considers: (1) loan application, (2) credit report, (3) appraisal of property
 The risk of the loss is priced into the rate charged for the loan (Credit Spread).


Is the goal never to take a loss?
The only way to guarantee zero losses is zero credit!
Baruch College: RES3200
Residential Loan Underwriting
The Underwriter
5
 Is there conflict between the originator (broker) and the underwriter?


Mortgage broker paid if the borrower approved
Underwriter in trouble if the borrower defaults
Make the Loan!!!
Don’t make the Loan
really big apple savings
collateral
the loan officer
the johnson's
Baruch College: RES3200
the underwriter
Residential Loan Underwriting
Roadmap
6
 What is underwriting? Who is an underwriter?
 3 C’s of underwriting: Credit, Capacity, Collateral
 Default insurance: Government (tax-payer) insurance vs PMI
 Types: conventional, FHA\VA, Jumbo, Subprime
 Loan Level Price Adjustment (LLPA)
 Underwriting Example
 Loan Modifications
 Rental Underwriting
Baruch College: RES3200
Residential Loan Underwriting
Why Do Borrowers Default?
7
 The underwriter thinks about the borrower’s future:

Ability to Pay (ATP) and Willingness to Pay (WTP)
 Distress Default: borrower’s becomes unable to pay


income falls (e.g. loss of job)
the payment rises (eg rate on ARM increases). Equivalent to a drop in income.
 Strategic Default: borrower becomes unwilling to pay


If price < balance the borrower loses option to sell house for more than he owes.
borrower is able to pay but chooses not to (deep negative equity)


Recourse vs Non-recourse, the economic considerations.
Ethical considerations and stigma
 Most foreclosures are double-trigger: unable and unwilling to pay
Baruch College: RES3200
Residential Loan Underwriting
Why Do Borrowers Default? Stigma
8
 Default used to have a stigma (affects WTP).
 "Bankruptcy should be difficult, and the moral stigma that used to be associated with
bankruptcy ought to be resurrected.”

Senator Grassley
 “The explosion in bankruptcy filings has less to do with causes and more to do with
motivations. The stigma of bankruptcy is all but gone.”

Senator Hatch
 “There has been a decline in the stigma of filing for bankruptcy.”

Senator Kerry
 “The social stigma of bankruptcy is gone”

Senator Dodd
 “Personal bankruptcies are soaring because Americans have lost their sense of
shame.”

Fed Chairman Greenspan
 Singapore newspapers publish names of bankruptcy filers!
Baruch College: RES3200
Residential Loan Underwriting
3 Cs of Underwriting
9
 CREDIT: credit report (Transunion, Experian, Equifax)




Credit report includes a FICO score 300-850
Current and past debts, missed payments, bankruptcies, deficiencies etc
Thin credit file: to date no credit balance >$5k (excluding student loans)
Short credit file: duration <2 years
 CAPACITY: borrower’s capacity to make loan payments (ATP)


Employment history, income statements (stubs), bank asset statements
DTI front end and back-end, Payment-To-Income (PTI) requirement, PITI (Principal + Interest + Taxes +
Insurance)
➢
Verification of assets (bank accounts…). Proof you can make down payment.
Lenders care if down payment from borrower (“equity is equity”)

Reserve Requirement: e.g. enough assets in bank to pay mortgage for a few months

 COLLATERAL: the value of the collateral in case of default (WTP)


Appraisal report (3rd party appraiser hired by lender)
LTV requirement: if LTV>80% need Private Mortgage Insurance (PMI)

Loans w/ higher LTVs are riskier, often have higher interest rates or require higher FICO
 Lenders use the 3 Cs to determine:


Extensive margin: if you will be approved for a loan
Intensive margin: under what terms (rate, points, maximum LTV etc)
Baruch College: RES3200
Mortgage brokers before fin. crisis
10
 3-minute clip from Big Short movie (start from 0:55)

If video doesn’t open, here is the link https://youtu.be/PgGLgygsqus?t=55
Baruch College: RES3200
Residential Loan Underwriting
Lower underwriting standards
11
 Low standards (3Cs) during the housing boom. Much higher standards after bust.
Baruch College: RES3200
12
 Distribution of US Households in 2016
10k
households
10k USD
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10k
households
10k USD/year
13
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Fraction of
households
Residential Loan Underwriting
Distress Sales & Default
14
Example
 current balance 𝐵𝑡 = $160𝑘, 𝑃𝑀𝑇 = $860
 𝑃𝑇𝐼𝑚𝑎𝑥 = .50


will not pay if income falls below 2 * PMT = $1720
“can not pay”
Home
Value
Income
Baruch College: RES3200
Residential Loan Underwriting
Distress Sales & Default
15
Example
 current balance 𝐵𝑡 = $160𝑘, 𝑃𝑀𝑇 = $860
 𝑃𝑇𝐼𝑚𝑎𝑥 = .50




will not pay if income falls below 2 * PMT = $1720
“can not pay”
will not pay if home value falls below current balance
“does not want to pay”
 4 areas




Home
Value
Repay: can and want to pay
Distress Sale: wants to pay but cannot
Strategic Foreclosure: can pay but doesn’t want to
Foreclosure: neither can nor wants to pay

also called “double trigger” foreclosure
Income
Baruch College: RES3200
Residential Loan Underwriting
CREDIT: FICO Score
16
 A snapshot of risk that shows the credit history/behavior of the borrower.

A numerical system that ranges from 300 – 850.
 Measures the likelihood of a borrower being 60 - 90 days late on a payment.

The higher the score, the lower the probability of loan default risk.
 Created by (William Fair & Earl Isaac) Fair Isaac Corporation in 1956.

FICO creates proprietary software used by consumer credit reporting agencies to compute score.
 3 main providers of the FICO score: Transunion, Experian, Equifax(+PRBC &
Innovis)

Agencies create credit report and use FICO software to compute score.
Baruch College: RES3200
Residential Loan Underwriting
CREDIT: FICO Score
17
 The average FICO score is 687
 The median FICO score is 723 (half 300-723 & half 724-850)
FICO Score Distribution
Score
300 - 499
500 - 549
550 - 599
600 - 649
650 - 699
700 - 749
750 - 799
800 - 850
Baruch College: RES3200
% of population Cummulative
2%
5%
8%
12%
15%
18%
27%
13%
2%
7%
15%
27%
42%
60%
87%
100%
Delinquency Rate
(probability of being
90 days late)
87%
71%
51%
31%
15%
5%
2%
1%
Residential Loan Underwriting
CREDIT: FICO Score
18
 What factors influence the FICO score?
 FICO doesn’t reveal the exact algorithm (proprietary)

35% - Payment history


30% - Credit Utilization – credit usage/credit availability ratio



The longer you have been a borrower the better.
10% - Types of credit used


Don’t use your entire credit limit on any one card.
Closing an unused credit card actually hurts (bc it reduces credit availability).
15% - Length of credit history


On time payments improve score.
The more types of borrowing the better/ unless high cost borrowing.
10% - Recent Credit searches


Borrowers who recently do a lot of searches are believed to be riskier.
The more often you apply the lower the score temporarily.
 Q: why do different bureaus give (slightly) different FICO scores?
 A: some creditors report hard inquiries to only one bureau (etc)
Baruch College: RES3200
Credit score alternative
19
 Albanesi (2019)


Machine Learning (Deep Neural Networks) improves default prediction
Why? Complicated patterns in data, can benefit from better techniques
 Main predictors of default

Length of credit history, time since last delinquency, number of credit cards
Baruch College: RES3200
Credit score alternative
20
 What is Machine Learning (ML)?
 Originally: computer performs a task w/o explicit instructions
No ML: researcher (1) tries an idea, (2) looks at results,
(3) updates the idea based on the results; tries again until success…
 With ML: researcher writes a code to run all three steps automatically
until success


Now / Econ & Finance: roughly, any new technique to analyze data
no magic, just progress: techniques evolve, many new ones have more
‘automatic’ steps, so they get label ‘Machine learning’ that’s popular
 i.e. ML is useful for most tasks that require complicated data analysis

 I highly recommend taking a machine learning class!
It’s good for many jobs and for your CV for about any job.

Baruch offers some, you can also find many on Coursera etc
Baruch College: RES3200
Residential Loan Underwriting
CAPACITY: Income Analysis
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 Front-end PTI – Front-end Payment to Income Ratio

The ratio of the borrower’s monthly real estate related payments, including the mortgage payment,
property taxes, mortgage insurance and property insurance, homeowner association fees (HOA), to their
gross, pre-tax monthly income.

𝑃𝑇𝐼 𝐹𝐸 =
𝑃𝐼𝑇𝐼𝑀
𝐼𝑛𝑐𝑜𝑚𝑒
 Back-end PTI – Back-end Payment to Income Ratio


The ratio of the borrower’s total debt payments, including mortgage payments, car loans, credit card
loans, student loans etc to their gross, pre-tax income.

𝑃𝑇𝐼 𝐵𝐸 =
𝑃𝐼𝑇𝐼𝑀+𝑜𝑡ℎ𝑒𝑟 𝑑𝑒𝑏𝑡
𝐼𝑛𝑐𝑜𝑚𝑒
Other names for the same concepts:


Front-end/Back-end Debt to Income Ratio (DTI) = exact same as PTI as above (not ratio of debt to income)
Textbook uses the concept of PTI (payment to income ratio) and TDR (total debt ratio)
 Ratio limits have tended to be:
 Conventional limits (FNMA & FHLMC)
 Federal Housing Administration
Baruch College: RES3200
28%/36%
31%/43%
Residential Loan Underwriting
CAPACITY: Income Analysis
22
 In our example:
 Mr. Johnson makes $7,083/month. What mortgage can he afford?
 Front-end PTI test
 Back-end PTI test
=7083 * 28%
= 7083 * 36%
=
=
$1,983
$2,550
MOST amount allowed
For ALL real estate
expenses
 If Mr. Johnson’s total housing 𝑝𝑚𝑡 = 1983, he can’t have more than 2550 −
1983 = 567 in other monthly loan payments.

Mr. Johnson must satisfy BOTH the Front and Back-end PTI tests.
 What loan would the Johnson’s qualify for using the front-end PTI ratio?

NOTE: You do NOT need to know the house price to qualify the Johnson’s based on the PTI.
Baruch College: RES3200
Residential Loan Underwriting
CAPACITY: Income Analysis
23
 Q: What Does $1,663/month Afford?

A: depends what kind of mortgage you get
$1,663 < $1,983.
 All of the below options work using a front-end DTI of 28%.

(note: still haven’t computed back-end PTI)
 How much can you spend on a house with an 80% LTV mortgage?
1
2
3
4
Fixed Rate 15 Year
PMT
1,663.26
Loan
197,102.00
N
15
I
6.00%
Fixed Rate 30 Year
PMT
1,663.26
Loan
250,000.00
N
30
I
7.00%
Fixed Rate 30 Year - IO
PMT
1,663.26
Loan
285,130.00
N
30
I
7.00%
ARM 30 year 5.0%
PMT
1,663.26
PV
309,834.00
N
30
I
5.00%
80% LTV
80% LTV
80% LTV
80% LTV
246,377.50
312,500.00
356,412.50
•
The same $1,663.26 can purchase many homes!!
•
NOTE: to compute PMT on IO use
•
We are assuming he can afford the down payment for an 80% LTV loan!
Baruch College: RES3200
7%
12
× 𝐵0 = 1,663.26 (solve for 𝐵0 )
387,292.50
Residential Loan Underwriting
CAPACITY: Income Analysis
24
 Taxes and insurance go into the PTI.

Property taxes and some insurance plans are paid annually.
 Many mortgages require an escrow account which collects the property taxes
and insurance premia monthly.
 The monthly payment= Mortgage + Taxes + Insurance

The servicer pays the insurance premium to insurer & taxes to govt each year.
 Q: why do lenders care about property taxes? Insurance?
 A: if the house burns down & borrower defaults -> no house
 Example: annual property taxes are $12k to be paid once/year.


The mortgage requires the borrower to pay $1k/month in taxes.
This is saved in an escrow account @ zero interest and is used to pay the property taxes.
Baruch College: RES3200
Residential Loan Underwriting
Collateral: Skin in the Game
25
 LTV (loan to value): ratio of the loan amount to the appraised value of the property.
 A higher LTV corresponds to a higher probability of negative equity & default.
 A higher LTV leads to a higher degree of severity for the lender.
𝐷𝑒𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦𝑡
𝐵𝑎𝑙𝑎𝑛𝑐𝑒𝑡

𝑆𝑒𝑣𝑒𝑟𝑖𝑡𝑦𝑡 ≡


Ex: A bank sells a house for $225k when the loan balance is $275k.
𝐷𝑒𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 = 275𝑘 − 225𝑘 = 50𝑘

𝑆𝑒𝑣𝑒𝑟𝑖𝑡𝑦 =
50𝑘
275𝑘
(Recovery Rate = 1-Severity)
≈ 18% (the lender lost 18% of the balance, recovered 82%)
 More restrictive underwriting standards including lower LTV limits can result in
lower severities.
 Lenders require independent appraisals to make sure the collateral is worth close to
what you are paying.
Baruch College: RES3200
Residential Loan Underwriting
Roadmap
26
 What is underwriting? Who is an underwriter?
 3 C’s of underwriting: Credit, Capacity, Collateral
 Default insurance: Government (tax-payer) insurance vs PMI
 Types: conventional, FHA\VA, Jumbo, Subprime
 Loan Level Price Adjustment (LLPA)
 Underwriting Example
 Loan Modifications
 Rental Underwriting
Baruch College: RES3200
Residential Loan Underwriting
Default Risk
27
 Q: Who bears the risk when a borrower defaults?
 A: Borrower, Lender & Insurer
 Borrower: faces long term restrictions on credit availability.

Foreclosure remains on the credit record for 7 years.
 Lender: faces possible deficiency upon liquidation of the property.



Deficiency if Proceeds from sale < Loan Balance
The owner can be the originator or any investor who purchased all or part of the loan.
Most mortgages are either sold to 3rd parties or packaged into securities.
 Mortgage Insurer: (if there is one) insures some of the lender’s deficiency risk.


Two kinds: Government & Private Mortgage Insurance (PMI) – sometimes both
Government: FNMA, FHLMC and GNMA are essentially mortgage insurers.


With any government “insurance” the tax-payer is on the hook
Lenders often require borrowers to purchase 3rd party PMI in addition to government insurance.

Conforming loans require PMI for portion of loan > 80% LTV
Baruch College: RES3200
Residential Loan Underwriting
Mortgage Insurance
28
 Example: 𝐻𝑃0 = $100𝑘, 𝐵0 = $95𝑘 (IO loan), 𝐿𝑇𝑉0 = 95%
 Government (GSE) insures the first 80% LTV ($80k) from deficiency


Lender pays GSE monthly premium (G-fee)
GSE will pay lender up to $80k if there is a deficiency (remaining after PMI)
 Lender requires PMI for portion of loan above 80% LTV (amount above $80k)




Borrower must insure: $95𝑘 − $80𝑘 = $15𝑘
Borrower pays insurer monthly premium
Private insurer will pay lender up to $15k if there is a deficiency
Private insurer pays first. If it’s not enough to cover the deficiency and there is GSE insurance, GSE pays the rest
 Foreclosure in 5 years: 𝐻𝑃60 = $83𝑘, 𝐵60 = $95𝑘


𝐷𝑒𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦60 = 𝐵60 − 𝐻𝑃60 = $95𝑘 − $83𝑘 = $12𝑘
Private insurer pays the bank $12k, since 𝐷𝑒𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦60 ≤ $15𝑘
 If 𝐻𝑃60 = $78𝑘, 𝐵60 = $95𝑘




𝐷𝑒𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦60 = 𝐵60 − 𝐻𝑃60 = $95𝑘 − $78𝑘 = $17𝑘
Private insurer pays the bank $15k
GSE pays the bank $2k
If no GSE, the bank’s loss =$2k
Baruch College: RES3200
Residential Loan Underwriting
Mortgage Insurance
29
 Private Mortgage Insurance (PMI)
 Premia typically between 30bps to 120bps of the principal amount of the loan.
 Can be paid ongoing (monthly) or in a lump sum at origination.
 Typically once the loan amortizes below 78% the policy is cancelled.
 Tax Relief and Health Care Act of 2006
 PMI: 2007-2014 is tax deductible, only for loans taken after 1-1-2007
 7 private insurers pre-crisis

2 went bankrupt: PMI group (2011) & Triad Guaranty (2013) →lenders not paid

5 others: Genworth, Radian, United Guaranty, MGIC and Arch
 Government Insurance (GSE: FN or FH)
 Guarantee-fee (g-fee) approx 50 – 60 basis points.

Banks pay g-fee to GSEs, and pass onto borrowers through higher rates
 The g-fee is built into the borrowing rate and goes to FN & FH to build reserves for
future losses.

Insurance company: collect premia, invest it & pay claims
Baruch College: RES3200
Residential Loan Underwriting
Roadmap
30
 What is underwriting? Who is an underwriter?
 3 C’s of underwriting: Credit, Capacity, Collateral
 Default insurance: Government (tax-payer) insurance vs PMI
 Types: conventional, FHA\VA, Jumbo, Subprime
 Loan Level Price Adjustment (LLPA)
 Underwriting Example
 Loan Modifications
 Rental Underwriting
Baruch College: RES3200
Residential Loan Underwriting
Types of Mortgage Loan Programs
31
 Banks have large menus of loans (https://www.wellsfargo.com/mortgage/rates/)
 Conventional (Conforming) Mortgages: insured by FNMA/FHLMC (FN/FH)
 Good FICO, low PTI, low LTV. Loan not too big (below Conforming Limit).
 Insurance premia paid by lender (g-fee monthly) and depends on risk
 Government Mortgages: FHA/VA insured (securitized by Ginnie Mae)
 Riskier (lower FICO, higher PTI, higher LTV). Often smaller.
 Premia paid by borrower. No risk-based pricing unlike GSE (except HERA, July- Oct 2008)


Up Front Mortgage Insurance Premium (UFMIP): 175bps
Annual Premium: 85bps
 Jumbo Mortgages (non-conforming)
 Above conforming limit (usually good credit) sometimes require PMI
 Subprime Mortgages
 Risky. FICO<620, very high LTV.
 Mortgages not insured by the government are either “held on the books” of a bank or
privately securitized (PLS).
Baruch College: RES3200
Residential Loan Underwriting
Conventional Mortgages
32
 GSEs (Government Sponsored Enterprises) FN/FH created by govt


there are a few, e.g. Federal National Mortgage Association (aka FNMA, Fannie Mae), Federal Home Loan Mortgage
Corporation (FHLMC, Freddie Mac)
note: Government National Mortgage Association (GNMA, Ginnie Mae) is not a GSE but gov’t owned corporation
 GSEs regulated by FHFA (Federal Housing Finance Authority) created 2008
 If loans meet certain underwriting criteria the lender can pay the GSE a g-fee and
transfer the risk of loss from lender to the GSE.

If the loan is pooled and sold to investors the guarantee is transferred as well.

g-fee paid by lender, but in reality passed on to the borrower via higher interest rate
2011-2015: average g-fee more than doubled from 26bps to 59bps

 Generally these loans provide the lowest borrowing cost to home buyers.

These costs have been rising since the financial crisis.
 Government guarantee (implicit) allows GSEs to borrow almost @ Treasury rate

US govt (tax payer) spent $180B to help GSEs stay solvent during crisis.
Baruch College: RES3200
Residential Loan Underwriting
Conventional Mortgages
33
 Conforming Loan Limit (CLL) on a single-family home $417k (GSE) & $271k (FHA)

Higher limits in high cost regions. Up to 4 unit multi-family house
 Credit: minimum FICO requirements



FRM (Fixed Rate)
ARM (Adjustable)
IO
-
620 minimum FICO
640 minimum FICO
720 minimum FICO
 Capacity: Front-end PTI = 28%
 Capacity: Back-end PTI

= 36% - 45%
(This can move around)
Minimum reserve requirements in certain cases (2 months).
 Collateral: if LTV>80%, borrower must get PMI for amount > 80%
Baruch College: RES3200
Residential Loan Underwriting
Sample Eligibility Requirements
Means: Borrower must have a
minimum 680 FICO if he/she wants
a greater than 75% LTV
34
Really Big Apple Bank Single Family Loan Residential Qualification Matrix
Number of Units =
1
No Reserves Required
Transaction Type
Principal Residence
Purchase
Cash-Out Refinance
Second Home
Purchase
Cash-Out Refinance
Baruch College: RES3200
Maximum LTV
DTI </= 36%
DTI </= 45%
Credit Score Minimum
Credit Score Minimum
FRM: 95%
ARM: 90%
FRM: 680 if >75%
FRM: 620 if </= 75%
ARM: 680 if >75%
ARM: 640 if </= 75%
700 if > 75%
640 if </= 75%
FRM: 85%
ARM: 75%
680 if >75%
660 if </= 75%
700 if > 75%
680 if </= 75%
FRM: 90%
ARM: 80%
FRM: 75%
ARM: 65%
680 if >75%
640 if </= 75%
680 for both
FRM: 700 if > 75%
NOT available for ARMs
FRM: 700 if > 75%
NOT available for ARMs
Residential Loan Underwriting
Did Securitization Lead to Lax Screening? QJE 2010
35
 Loans w/ FICO<620 are harder to securitize (≈sell) than FICO≥ 620
 Not all loans w/ 620 FICO are equally risky.
 Q: were borrowers w/ 𝐹𝐼𝐶𝑂 ≥ 620 screened more laxly?
 Strategy: FICO 621 very similar risk to 619, much more likely to be approved
 Portfolio of loans easier to
securitize defaulted 10%-25% more
than a similar risk profile group.
 A good example of research


Clear idea, nicely executed
Shows lax screening with data
instead of speculating about it
Baruch College: RES3200
Residential Loan Underwriting
Roadmap
36
 What is underwriting? Who is an underwriter?
 3 C’s of underwriting: Credit, Capacity, Collateral
 Default insurance: Government (tax-payer) insurance vs PMI
 Types: conventional, FHA\VA, Jumbo, Subprime
 Loan Level Price Adjustment (LLPA)
 Underwriting Example
 Loan Modifications
 Rental Underwriting
Baruch College: RES3200
Residential Loan Underwriting
The Rate Sheet: Loan Level Price Adjustments (LLPA)
37
 Pricing adjustments from lender that reflect the characteristics of the borrower.

Safer borrowers can get lower rates.
 The numbers below reflect the cost of the loan.


If a borrower had a 730 FICO and 80% LTV, there is 0 adjustment.
If a borrower had a 670 FICO and 80% LTV there would be a 1.25 point adjustment.

Meaning an additional 1.25% cost to the loan as expressed in points.
 Either the lender charges 1.25 points now, or raises the rate to get same IRR
CONVENTIONAL PROGRAM/LTV PRICING
ADJUSTMENTS
Loan-To-Values:
FICO >=740
FICO 720 - 739
FICO 700 - 719
FICO 680 - 699
FICO 660 - 679
FICO 640 - 659
FICO 620 - 639
FICO <620
<=60.00
(0.25)
(0.25)
(0.25)
0.00
0.00
0.00
0.00
1.00
Baruch College: RES3200
60.01 70.00
0.00
0.00
0.50
0.50
0.50
0.50
0.75
1.00
70.01 - 75.00
0.00
0.00
0.50
0.50
1.25
1.75
2.50
2.75
75.01 - 80.00
0.00
0.00
0.50
0.50
1.25
1.75
2.50
2.75
80.01 - 85.00
0.00
0.00
0.50
0.50
1.25
1.75
2.50
N/A
85.01 - 90.00
0.00
0.00
0.50
0.50
1.25
1.75
2.50
N/A
90.01 - 95.00
0.00
0.00
0.50
0.50
1.25
1.75
2.50
N/A
95.01 - 97.00
0.00
0.00
0.50
0.50
N/A
N/A
N/A
N/A
97.01 -100
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
Residential Loan Underwriting
The Rate Sheet: Loan Level Price Adjustments (LLPA)
38
 Let’s examine what this means.
 Assume the borrower had a 670 FICO and the loan was 80% LTV.
 The lender requires a yield of 7.125% from this loan.
 There are 2 options for the lender.
1.
2.
The bank could charge the borrower 1.25 in fees (points now)
Or adjust the rate on the loan to reflect the charge.
 The bank is indifferent because the APR/Effective Interest is the same.
 Compare the 2 options.
Baruch College: RES3200
Residential Loan Underwriting
The Rate Sheet: Loan Level Price Adjustments (LLPA)
39
Option #1: Fees Upfront
Option #2: Increase the Rate
Loan Amount
N
Interest Rate
PMT
Loan Amount
N
Interest Rate
PMT
=
=
=
=
250,000
360
7.125%
1684.30
APR
=
7.125%
=
=
=
=
250,000
360
7.00%
1663.26
Fees
1.25% x 250,000 =
3,125
Adj PV
=
246,875
APR
=
7.125%
Q: if you are a borrower, what would you prefer?
Baruch College: RES3200
Residential Loan Underwriting
Roadmap
40
 What is underwriting? Who is an underwriter?
 3 C’s of underwriting: Credit, Capacity, Collateral
 Default insurance: Government (tax-payer) insurance vs PMI
 Types: conventional, FHA\VA, Jumbo, Subprime
 Loan Level Price Adjustment (LLPA)
 Underwriting Example
 Loan Modifications
 Rental Underwriting
Baruch College: RES3200
Residential Loan Underwriting
Let’s Get Back to the Johnson Family
41
 The Johnson’s want to buy a home that costs $312,500.


Mr. Johnson makes $85,000/year ($7,083.33/mo).
And he has saved $62,500 (for a down payment).
 Underwriter determines Johnson’s have $600 in other monthly debt



car loan ($250/month)
average credit card bill ($200/month)
student loan payment ($150/month)
 New home requires $150/month in taxes & insurance


monthly property taxes of $100/month
insurance of $50/month
Baruch College: RES3200
Residential Loan Underwriting
Underwriting Example
42
 Mr. Johnson makes $7,083/month. What PMT can he afford?
 Front-end DTI test
 Back-end DTI test
=
=
28%
36%
=
=
$1,983
$2,550
 Mr. Johnson’s must satisfy BOTH the Front and Back-end DTI tests.
 What loan would the Johnson’s qualify for using the front-end DTI ratio?
Baruch College: RES3200
Residential Loan Underwriting
Underwriting Example
43
Annual Income
Monthly Income
Frontend DTI
Backend DTI
85,000
7,083
28%
36%
Housing Expenses/month
Principal & Interest
Taxes
Insurance
Other debt/month
Car Loan
Credit Card
Student Loan
Total Debt
• Johnsons pass both FE & BE tests. Approved!
Baruch College: RES3200
Cost
=
LTV
Balance =
Term
=
Rate
=
PMT
=
1,983
2,550
1,663
100
50
1,813
26%
<
28%
34%
<
36%
250
200
150
600
2,413
$ 312,500
80.0%
$ 250,000
30 years
7.00%
$ 1,663.26
Residential Loan Underwriting
How Much Can the Johnson’s Pay?
44
 Suppose the Johnson’s got into a bidding war for the home.
 How much could they afford to pay monthly and still not exceed the DTI tests?

Remember they need to meet both tests.
 Assuming that other debt costs don’t go up.
 Room under frontend DTI test
 Room under backend DTI test
= 1,983 – 1,813 = 170
= 2,550 – 2,413 = 137
 Since 137 < 170 they could increase the monthly mortgage payment by $137.
 That would mean they could pay 1,663 + 137 = $1,800
 Which equates to a $270,553 mortgage at 7.0%.
 Which would mean they could pay 270,553Τ.80 = $338,191 or $25,697 more.
Baruch College: RES3200
Residential Loan Underwriting
Affordability Products
45
 What if there was a 3/1 ARM available at 5.0%
 That is an initial monthly payment of $1,342
for a $250,000 loan.
 What if the bank qualified a borrower at the initial rate but failed to consider
what happens at the reset?
 If the Johnson’s qualify at $1,800/month how could they pay?
 Work backwards from the maximum $1,800.
 The mortgage max = $335,306 or at 80% LTV = $419,133 home value.
Baruch College: RES3200
Residential Loan Underwriting
Affordability Products
46
 What happens when the $335,306
Balance t = 36
N
Future Mtg Rate
Future Payment
=
=
=
=
loan resets?
 First - what is the loan balance after 3 years? 𝐵36 = $319,692
 Assume the index in 3 years is 4.00% at reset.

319,692
324
6.75%
2,147.05
The new mortgage rate = 4.00 + 2.75 = 6.75%.
 The new monthly payment = $2,147.05
 A jump of $347.05/month.
(2,147.05 – 1,800.00)
 If a borrower qualified at the maximum limit at origination and their income
did not go up then the borrower would now be below both PTI ratios today
and would not have qualified.
 Think of the consequences if home values had declined.
Baruch College: RES3200
Residential Loan Underwriting
Roadmap
47
 What is underwriting? Who is an underwriter?
 3 C’s of underwriting: Credit, Capacity, Collateral
 Default insurance: Government (tax-payer) insurance vs PMI
 Types: conventional, FHA\VA, Jumbo, Subprime
 Loan Level Price Adjustment (LLPA)
 Underwriting Example
 Loan Modifications
 Rental Underwriting
Baruch College: RES3200
Residential Loan Underwriting
Loan Modifications
48
 The financial crisis led to a rapid
increase in defaults.
 Unemployment went up, incomes
went down → lower ability to pay
 House prices fell, many household
underwater → lower willingness
to pay

Loan Balance > Market Value of the home
Baruch College: RES3200
Residential Loan Underwriting
Loan Modifications
49
 A lender may modify the terms of the mortgage loan if a borrower is behind
 4 Potential Modification Options, mostly to reduce monthly payment




Extend the term of the loan
Lower the interest rate
Defer the payments (take a break now but maybe at a cost of larger payments later)
Reduce the principal
 Rates fell after 2008 but banks were reluctant to allow underwater borrowers to refi
 Home Affordable Refinance Program: created to allow FN/FH borrowers to refi, no
matter how deep underwater

For loans originated before 5/31/2009
 Home Affordable Modification Program: created to help borrowers avoid foreclosure



Subsidize poor mortgage borrowers with high PTI to bring their PTI to down to 31%
Only for loans originated before 1/1/2009, but don’t kick out of program is enrolled and e.g. income went up later
Free money, large subsidies (average 40% of pmt!), still less than half of eligible applied (many did not know)
Baruch College: RES3200