Applying for a Mortgage Loan .net

LP-11 Required Reading Part One

Applying for a Mortgage Loan

When it's time to arrange financing, a home buyer must shop for a loan, choose a lender, and fill out a loan application. Then the lender will evaluate the application and decide whether or not to approve the loan. The first part of this chapter describes the different types of lenders in the primary market, explains loan fees, and discusses the Truth in Lending Act, a law that helps prospective borrowers compare loans. The next section covers the loan application form and the underwriting process. The section after that describes various features of a home purchase loan and provides an overview of the major residential finance programs. The chapter ends with a discussion of the problem of predatory lending.

Choosing a Lender

Many home buyers look to their real estate agent for guidance in choosing a lender. Agents should be familiar with the lenders in their area and know how to help buyers compare the loans that different lenders are offering. We're going to discuss the various types of lenders that make home purchase loans, the fees that lenders charge, and the Truth in Lending Act.

Types of Mortgage Lenders

Most home buyers finance their purchase with a loan from one of these sources of residential financing:

commercial banks, thrift institutions, credit unions, and mortgage companies.

At one time, financial institutions in the United States were quite specialized. Each type of institution served a different function; each had its own types of services and its own types of loans. In recent decades, federal deregulation of depository institutions removed many of the restrictions that

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differentiated them. To a great extent, all depository institutions can now be regarded as "financial supermarkets," offering a wide range of services and loans--including residential mortgage loans.

There still are differences between the various types of mortgage lenders, in terms of lending practices and government regulations. Those differences don't necessarily affect a loan applicant who wants to finance the purchase of a home, however. A home buyer decides between two lenders because of the types of loans they're offering, the interest rates and fees they're charging, and the quality of service they provide, not because one is a savings and loan and the other is a mortgage company. Even so, it's worthwhile to have a general understanding of the different types of mortgage lenders.

Commercial Banks. A commercial bank is either a national bank, chartered (authorized to do business) by the federal government, or a state bank, chartered by a state government. Commercial banks are the largest source of investment funds in the United States. As their name implies, they were traditionally oriented toward commercial lending activities, supplying shortterm loans for business ventures and construction activities.

In the past, residential mortgages weren't a major part of commercial banks' business. That was partly because most of their customer deposits were demand deposits, subject to withdrawal on short notice or without notice, like the money in checking accounts. So the government limited the amount of long-term investments commercial banks could make. But eventually banks began accepting more and more long-term deposits; demand deposits now represent a considerably smaller share of banks' total deposits than they did at one time.

While banks have continued to emphasize commercial loans, they have also diversified their lending, with a substantial increase in personal loans and home mortgages, especially to already-existing customers. They now have a significant share of the residential finance market.

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Thrift Institutions. Savings and loan associations and savings banks are often grouped together and referred to as thrift institutions, or thrifts. Like commercial banks, thrifts are chartered by either the federal government or a state government.

Savings and Loans. Savings and loans (S&Ls) started out in the nineteenth century strictly as residential real estate lenders. Over the years they carried on their original function, investing the majority of their assets in purchase loans for single family homes. By the mid-1950s, they dominated local residential mortgage markets, becoming the nation's largest single source of funds for financing homes.

Many factors contributed to the dominance of savings and loans. One of the most important was that home purchase loans had become long-term loans (often with 30 year terms). S&Ls used the savings deposits of their customers as their main source of loan funds. Since most of the funds held by S&Ls were long-term deposits, S&Ls were comfortable making long-term home loans.

While savings and loans are involved in other types of lending, home mortgage loans remain their main focus. However, due to the increasing involvement of other types of lenders, S&Ls no longer dominate the residential finance market.

Savings Banks. Like S&Ls, savings banks also got their start in the nineteenth century. They offered financial services to small depositors, especially immigrants and members of the working class. They were called mutual savings banks (MSBs) because they were organized as mutual companies, owned by and operated for the benefit of their depositors (as opposed to stockholders).

Traditionally, MSBs were similar to savings and loans. They served their local communities. Their customers were individuals rather than businesses, and most of their deposits were savings deposits. Although the MSBs made many residential mortgage loans, they didn't concentrate on them to the

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extent that S&Ls did. The MSBs were also involved in other types of lending, such as personal loans.

Today savings banks can be organized as mutual companies or stock companies. Residential mortgages continue to be an important part of their business.

Credit Unions. Credit unions are depository institutions, like banks and thrifts. But unlike banks and thrifts, credit unions often serve only members of a particular group, such as the members of a union or a professional association, or the employees of a large company.

Credit unions traditionally provided small personal loans to their members. In recent years, many credit unions have emphasized home equity loans. (A home equity loan is a mortgage on the borrower's equity in the home she already owns. See Chapter 9.) Now many credit unions also make home purchase loans.

Mortgage Companies. Unlike banks, thrifts, and credit unions, mortgage companies aren't depository institutions, so they don't lend out depositors' funds. Instead, they often act as loan correspondents, intermediaries between large investors and home buyers applying for financing.

A loan correspondent lends an investor's money to buyers and then services the loans (collecting and processing the loan payments on behalf of the investor) in exchange for servicing fees. Banks and thrifts sometimes act as loan correspondents, but mortgage companies have specialized in this role.

Mortgage companies frequently act on behalf of large investors such as life insurance companies and pension funds. These investors control vast amounts of capital in the form of insurance premiums and employer contributions to employee pensions. This money generally isn't subject to sudden withdrawal, so it's well suited to investment in long-term mortgages. Since these large investors typically operate on a national scale, they have neither the time nor the resources to understand the particular risks of local

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real estate markets or to deal with the day-to-day management of their loans. So instead of making loans directly to borrowers, insurance companies, pension plans, and other large investors often hire local loan correspondents. They generally prefer large, long-term commercial loans and stay away from high-risk, short-term construction loans.

Mortgage companies also borrow money from banks on a short -term basis and use the money to make (or originate) loans, which they then package and sell to the secondary market agencies and other private investors. Using short-term financing to make loans before selling them to permanent investors is referred to as warehousing.

Banks and thrifts generally keep some of the loans they make "in portfolio," instead of selling them to investors. In contrast, mortgage companies don't keep any of the loans they make. The loans are either made on behalf of an investor or else sold to an investor. In many cases, insurance companies, pension funds, and other large investors now simply buy loans from mortgage companies instead of using them as loan correspondents.

The number of mortgage companies increased rapidly during the 1990s, and they eventually came to dominate the residential finance market as savings and loans once had. Mortgage companies played a major role in the subprime lending boom, and recent problems in the subprime market have had a greater impact on mortgage companies than on other types of residential lenders, diminishing their market share. (Subprime lending is discussed later in this chapter.)

Mortgage companies are sometimes called mortgage bankers. Traditionally, a distinction was made between mortgage bankers and mortgage brokers. A mortgage broker simply negotiated loans, bringing borrowers together with lenders in exchange for a commission. Once a loan had been arranged, the mortgage broker's involvement ended. In contrast, a mortgage banker actually made loans (using an investor's funds or borrowed funds), sold or delivered the loans to an investor, and then (in many cases)

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