Understanding Mortgage Lending: Practical Advice from an Experienced Lender

Featuring Brad Zahra  VP | Sr. HLA | Chase Private Client, JPMorgan Chase

The mortgage lending process can be ripe with confusing terms and mountains of paperwork. To help make this process more transparent, we asked our trusted lender, Brad Zahra from JPMorgan Chase, to help us break things down. Whether you are a first-time homebuyer, reentering the market after owning for many years, or looking to expand your investments, Brad’s guidance will set you up for lending success.

What are mortgage rates, and how do they impact my buying options?

Let’s first define the term mortgage rate. A mortgage rate is defined as the interest rate as to which that rate is going to amortize [reduce or pay off] the loan. The higher the rate, the more expensive the loan will be, and the higher the monthly payment will be.

Interest rates, if on the higher end, are going to price out a lot of individuals out of the market because the cost to enter the market is higher, making it more difficult to afford monthly payments.

What should borrowers consider when comparing lending options/applying for a loan?

Reach out to a lender, whether it is one they know or a local bank, and ask for a mortgage prequalification or preapproval. The mortgage banker or loan officiator will walk [you] through the application process and the steps for qualifying. There are also multiple online lenders that individuals can research and find a lender that best suits their needs.

Can you explain the difference between being pre-qualified and pre-approved?

Prequalification is an early assessment based on application documents without considering supplemental income documents.

Preapproval means you are actually running the stated loan amount on your applications through the mortgage underwriting process. Here you have provided personal financial documents, so more information is verified, giving you a better sense of what you are able to borrow.

How do student loans and other debts impact a buyer’s ability to qualify for a mortgage?

The main determining factor to how much you can borrow is your debt to income ratio. The debt to income ratio is split into two parts, upfront and back-end. The upfront ratio calculates your mortgage payment (the liability you are about to get) against your monthly liabilities. If you have a credit card with $20,000, but the monthly payment is only $100, the lender will consider your monthly payment.

Student loans are a bit different. In deferment, your lender would count 1% of your student loan balance towards your liabilities. They may also consider the amount reported in your credit report. If this amount is greater than the 1%, the lender would use it for your liability amount.

Your back-end ratio is your prospective monthly payment plus your monthly liabilities in comparison to your monthly expenses. The best spot to be is anywhere with a debt to income ratio below 43% debt to income ratio on the back-end. Government FHA loans are more flexible, which can go up to a 50% debt to income ratio.

How does one qualify for a mortgage? What does the mortgage approval process look like?

In a mortgage, there are four essential pillars that a lender will consider:

Assets

Your assets are intended to cover down payments and closing costs. If your debt to income ratio is on the higher end, required reserves (money you currently have that is not being used towards transaction -can compensate DTI)

You can also receive a gift from a family member or someone you have a significant relationship with [to help contribute towards your assets.] Depending on the loan amount or loan product, you may need more assets along with gifts. Gifts can also be for the total downpayment amount.

Credit Score

Credit score [requirements] really vary from one lender to another. The minimum credit score required depends on the lender and their susceptibility to risk. Some may require a score of 620, some a score of 680. FHA Loans are more flexible here too, and you may qualify with a score as low as 600.

[The approval standards upheld by the lender] are referred to as overlays. While rates may vary across different lending institutions, the ECOA regulates minimum credit score requirements for an individual institution. To provide fairness for clients, lenders cannot approve a rate for one client they would reject for another.

Your credit score is also the major determinant of the interest rate you will pay, so the better your credit score, the better your interest rates.

Liabilities (Debt to Income)

[There are] two real categories of liability, one being revolving debt and the other installment debt.

Revolving Debt includes credit cards, home equity lines, or any sort of debt or line that you can add or decrease without applying to change the loan amount. There are specific percentages of revolving debt or credit utilization that will optimize your credit score; for more information, I recommend you reach out to a credit advisor.

Installment Debt refers to car payments or your outstanding mortgage. You have a certain amount of debt and you are paying it off every month.

A combination of revolving and installment debt is crucial for your credit score because you would be demonstrating the ability to use leverage or debt in a healthy way, which will increase your credit score. If you are not great at maintaining payments, it will adversely affect your credit score.

Income (& Employment History)

Best case scenario, someone has two years of continuous employment within the same line of work. This would mean you would have pay stubs & W2s to prove the stability of income. Sometimes, some buyers have just entered the professional world after college or graduate school with less professional experience. These buyers don’t necessarily need a longer proof of employment as long as they work in a field related to their area of study. In this case, someone can submit proof of educational history to help qualify them for a loan.

Self-employed people are a bit harder to qualify for loans because they have a lot of leeway in calculating and determining their income. The income used for mortgage qualification will come straight from their tax returns, so the business needs to have at least two years of documented tax returns. A mortgage lender will come up with an average of two years of income from the business, which will help determine the applicant’s debt to income ratio and qualification amount. If self-employed individuals use their business income for qualification, they can also use their business assets for qualification if they own more than 25% of the business. Assets used need to be net the expenses recorded, which is another added requirement for self-employed applicants as annual balances and expenses will need to be provided.

What kinds of mortgage options would you recommend for first-time homebuyers?

This really depends on the client, as every individual has their own unique set of circumstances that could alter which program would be best for them and their goals. It is really important to connect with someone knowledgeable and experienced; that way, they can advise and place individuals in the right loan products for their situation and goals.

There is a misconception that there is a supreme loan product and a sub-prime loan product, but really it just depends on the client’s goals. A conventional loan product is utilized the most, as it is the least expensive if you have the ability to put 20% down. Conventional loans have some flexibility in down-payment, depending on the amount and also specific stipulations. Your credit score will also impact the down-payment amount and monthly payment. Whenever you reach 20% equity in a conventional loan, you no longer have to pay mortgage insurance. With FHA loans, the insurance remains throughout the life of the loan.

What are the benefits of a 15-year loan? A 30-year?

With a 15-year loan, you pay off the debt in a shorter period of time, but your interest rate is generally lower because of the duration of the loan. However, 15-year mortgages typically have a higher monthly payment.

With a 30-year loan, your monthly payment is lower, but the interest rate is higher. With the 30-year, you also have the ability to pre-pay towards the principal balance, which provides more flexibility.

Why does my lender require homeowner’s insurance?

Homeowners insurance is required on all properties to protect the collateral. Money is lent to you to help finance the home, a.k.a. the collateral. Homeowner’s insurance protects the collateral from damage or any unfortunate circumstances. Mortgage insurance is different from homeowners, as mortgage insurance is paid for by the client but only serves the lender in the case of default.

Finally, what are some things every buyer should know when applying or being considered for a mortgage?

1. You don’t need to buy a property at the max loan amount that you qualify for. Usually, you will need to aim lower than your qualification by about 30%, so you have more flexibility when it comes to the other costs associated with purchasing a home.
2. Always choose a well-experienced real estate agent. Whenever someone is purchasing a property, they are making money on the buyer’s side, not on the seller’s side. You want your agent to make sure the property is a good investment and will appreciate in value.
3. Choose a well-versed lender, so they can place you in the right products that are able to meet your goals. Some lenders won’t dive into the details regarding their client’s goals, who end up in loan products that aren’t right for them, which end up costing them more money.

Interested in learning more advanced tips from our lending guru? Tune in next week for part two!