Conniving lenders, inadequate regulation and public ignorance about the mortgage process create havoc for homebuyers when funding and closing escrow. Read up and lead your buyers through the perilous maze.

It’s not over ‘til it’s over: the pre-closing review

Attention buyer’s agents and loan brokers: don’t forget about the pre-closing review!

This fundamental practice was suspended during the Millennium Boom, but revived in 2010 by Fannie Mae under its Loan Quality Initiative. The Loan Quality Initiative requires lenders to establish minimum quality control processes to catch incorrect or incomplete loan information before funding. This quality control check verifies the homebuyer’s income, debts and assets are accurately reported on the loan application and considered in the underwriting decision.

Lender quality control processes vary by institution, but Fannie requires all lenders, at a minimum, to review:

  • data entered into an automated underwriting system;
  • the borrower’s social security number;
  • income calculations and supporting documentation;
  • employment documentation, including verbal verification of employment;
  • assets needed to close or meet reserve requirements;
  • the appraisal; and
  • documentation of adequate mortgage insurance coverage. [Fannie Mae 2013 Selling Guide D1-2-01]

Fannie doesn’t require all files be subject to quality control checks, but requires lenders to focus their pre-closing checks on loans which present greater risk of error, misrepresentation or fraud.

Loans which may be targeted for review include:

  • loans with complex income calculations (for example, rental income, self-employed, and short history of receipt of income);
  • loans requiring the use of non-standard processing or underwriting guidelines (for example, delayed financing, multiple financed properties, assets used as income, or manual reserve calculations);
  • loans secured by properties located in areas with high delinquency rates or areas experiencing rapid increases or decreases in property values;
  • loans with multiple layers of credit risk, such as high LTV ratios, low credit scores, or high debt-to-income (DTI) ratios;
  • loans originated or processed by newly hired loan officers, processors, appraisers, or other personnel or third parties involved in the loan origination process; and
  • loans for which the feedback or results from third-party tools indicate potential areas of concern. [Fannie Mae 2013 Selling Guide D1-2-01]

Editor’s note — Some lenders use automated pre-credit monitoring programs to track additional debt, or other changes which may impact the loan decision and trigger a change in loan terms.

Related article:
The lenders are watching

What’s the penalty for lax quality control? A lender that delivers Fannie Mae a loan which fails to meet Fannie’s qualification standards must buy it back. Thus, with their own financial responsibility suddenly on the line, lenders have become more than diligent in processing these pre-closing reviews.

Related articles:

Fannie Mae: Selling Guide Updates for the Loan Quality Initiative
Fannie Mae: Undisclosed Liabilities and Re-underwriting Requirements

What to expect on the pre-closing review

Lenders will not likely notify your homebuyer-applicant their purchase-assist loan is being subjected to another review. So it’s best to inform your homebuyer to simply avoid extra debt or other significant spending changes during the loan process. Maintain the status quo and an even keel, financially speaking.

But let’s say your homebuyer fails to heed your advice, and the lender’s review uncovers reduced income or additional debt or other cause for changing loan terms, after the loan has already been approved by underwriting.

If the new information causes the DTI to exceed the 45% maximum DTI set by Fannie, Fannie compels the lender to re-underwrite the loan. Fannie also requires a re-underwrite if the DTI increases by 3 percentage point or more, even if the maximum DTI doesn’t exceed 45%.

On top of these rules set by Fannie, the lender may choose to protect itself and simply re-underwrite the loan on any additional information it comes by. This gives the lender an opportunity to alter the terms of the loan (locked rate loans included) allegedly based on the new data. [Fannie Mae 2013 Selling Guide B3-6-02]

The RESPA/TILA refresh as a reset commitment

Even if homebuyers diligently practice safe spending prior to closing, they are still susceptible to last minute surprises due to permissible but deceptive lender behavior.

“Wait a minute,” you’re saying.  “Don’t RESPA and TILA control changes to loan terms once they have been disclosed to the homebuyer?”

Yes, it’s true – full and good faith disclosures and all that: both the Real Estate Settlement Procedures Act (RESPA) and the Truth in Lending Act (TILA) restrict a lender’s ability to change loan terms and costs.

However, RESPA and TILA allow lenders to refresh the documents (and terms and costs of the loan) up to three business days before closing.  The reason: lenders are required to establish transparency between lender and homebuyer.  Of course, three days before closing is never a timely disclosure. Buyers at that point have no alternative but to proceed with the bait and switch – unless they have that prudent back up by way of a second loan application to instantly turn to.

Regulation Z (Reg Z) implements the TILA requirement. Regulation Z disclosures are provided to homebuyers within three business days of the lender’s receipt of the loan application. Among other things, the Reg Z disclosures include the annual percentage rate (APR) charged on the loan. Further, the lender is to provide a corrected Reg Z disclosure if, at the time of closing, the annual percentage rate (APR) has changed more than:

  • 0.125% from the APR disclosed on the latest Reg Z disclosure given to the homebuyer on a regular transaction; or
  • 0.250% from the APR disclosed on the latest Reg Z disclosure given to the borrower for an  irregular transaction.

Editor’s note – An irregular transaction is any transaction which includes multiple advances, irregular payment periods and/or irregular payment amounts other than an irregular payment amount for the first or final payment (e.g., an adjustable rate mortgage is considered an irregular transaction.

At least three business days are to pass after the homebuyer receives the re-disclosure before the loan may close. [12 Code of Federal Regulations §§1026.19(a)(2), 1026.22(a)(2)-(3)]

The initial good faith estimate (GFE), required under RESPA and Regulation X at the time of the loan application, discloses all loan-related terms and charges on RESPA loans.

These items include:

  • the initial loan amount;
  • the loan repayment terms;
  • the initial interest rate;
  • origination charges and points/discounts;
  • credit report fees;
  • insurance costs;
  • prepaid interest; and
  • other loan closing charges. [Appendix C of 12 Code of Federal Regulations §1024]

At closing, an activity called settlement, the origination charge, the credit or charge for the locked interest rate and the adjusted origination charge for a locked interest rate disclosed in the GFE may not change.

Except, of course, when they CAN be changed. [12 CFR §1024.7(e)(1)]

The surprise of changed circumstance

Numerous exceptions allow the lender to change the loan terms after the GFE disclosure, simply called changed circumstances.

 Changed circumstances do not include market fluctuations by themselves. A lender may not openly change the origination charge or locked interest rate due solely to changes in market rates. [12 CFR §1024.2]

But here’s where lenders ooze through the cracks: if the lender discovers information relied upon to generate the GFE is inaccurate or incomplete, the lender can change the terms.

Such changed information consists of:

  • the credit quality of the borrower;
  • the amount of the loan;
  • the estimated value of the property; or
  • any other information relied upon to provide the GFE. [12 CFR §1024.2; 12 CFR §1024.7(f)]

This includes the discovery of additional debt, or reduced income.

In this way, the pre-closing check absolutely allows a lender to change terms of a loan, including, but not limited to, the charges associated with the interest rate and the loan origination fees. Thus, homebuyers are suddenly faced with increased charges and interest rates on their loan when market rates move and the lender no longer is making money at the quoted rate.

Still think RESPA only protects borrowers?

Power in numbers — enter Plan B

Your client doesn’t have to simply accept lender changes like a lamb trotting off to be slaughtered. The easy fix lies in an activity they do every day: shop.

Studies show Americans spend twice as long shopping for and researching their car purchase (small money compared to the mortgage) as they do the type of mortgage and terms they want for their home loan.

Lenders do not like competition. They abhor it. To compete without interference from other lenders, they encourage ignorant behavior by advising buyers not to submit multiple loan applications as it will, they allege, damage their credit. Not so, but when said by the steely-eyed loan officer or loan broker, this ploy seems convincing.

Applying to at least two mortgage lenders creates instant competition. To double down gives homebuyers a bargaining chip against a lender taking a mortgage application who at closing:

  • loads on garbage fees or changes the terms on a loan due to “changed circumstances”; or
  • denies the loan due to changed circumstances.

There are duplicated upfront costs associated with submitting two loan applications. However, the added expense is to be viewed as the premium paid to buy essential insurance against standard lender misbehavior. Without a contingency plan, a Plan B if you please, the homebuyer is at the lender’s mercy to take whatever higher costs the lender wants to charge. The point of no return has long been passed by the time the lender changes terms on the homebuyer, unless that Plan B is in place.

The GFE cuts both ways

Ironically, the GFE is meant to be used by homebuyers as a comparison tool. The GFE displays the loan information clearly on a uniform statement and in simple language. As identical forms will be used by all mortgage lenders, comparing two lenders is as simple as placing the two forms next to each other and, well, looking for the differences.

Editor’s note — If the Consumer Financial Protection Bureau (CFPB) ever releases the new Loan Estimate form — a fusion of the GFE and the Reg Z disclosures — homebuyers might have an even better tool with which to compare loan products. Alas, that form is currently in limbo, stymied by lenders citing the difficulty of compliance…

Related article:
The good faith estimate is designed for shopping around

The GFE and TILA assist homebuyers by red flagging lenders offering inflated charges at the time of application. Later, again, when a revised Reg Z disclosure and the HUD-1 form are provided three days before closing, the homebuyer has to compare them with the initial estimate of costs and rates worked up by the loan representative.

Further, compare that lender’s closing terms with loan rates and costs remaining available from the backup lender. If there is a significant discrepancy, the lender’s true colors are exposed. Thus, the homebuyer can successfully react – heading straight to the other lender with whom they have a parallel loan application.

Now let the negotiations begin! The time for closing has arrived.

Related articles:

Loan applications initiate the loan process
February Forms: Get your buyer the best financial advantage

“Preferred lenders” indicates a scam

A seller’s agent may inform a homebuyer or the buyer’s agent they have to use the seller’s “preferred lender” before the seller will accept the homebuyer’s offer. In other words, frankly, the seller’s agent is receiving an unlawful kickback from the lender if the homebuyer obtains financing from the broker-designated lender.

Though it may seem contradictory to do so, applying with multiple lenders is ideal in this situation as well.

Two applications avoid the potentially inflated cost due to the undisclosed kickback. With preferred lender treatment, you will experience a higher interest rate or points, or both. Someone has to pay for the lender’s added costs, and it is going to be the homebuyer. These are the reasons for RESPA and TILA disclosures, and two loan applications.

Buyers can begin the process with both the preferred lender and an alternate lender. Each lender is bidding for the mortgage business, whether or not they are aware of the parallel application. At closing, the homebuyer can select the better of the two, having retained “control” over the lenders through the competitive application process.

The homebuyer is never obligated to close with the “preferred lender.” Occasionally, the preferred lender language will appear in the purchase agreement. This is always an antitrust violation on the part of the  lender, or a lender violation of RESPA – to say nothing about the seller’s agent’s failure to disclose the kickback referral fee.

The “gatekeeper” is guardian of last resort

The homebuyer’s agent is the gatekeeper who initially brings the homebuyer into the marketplace.

Thus, on arranging a cash-to-new-loan purchase, the buyer’s agent needs to ensure the homebuyer obtains the home mortgage with the most favorable terms available for the class of loan they seek.

Though lenders always proclaim they offer the best rates and points available (and won’t hike them up at the very last second), it is foolish of the homebuyer and agent to believe this as unquestioned truth.

It’s either more points or higher interest when rates rise, or nothing when rates drop. It’s a one way street. The buyer’s agent has the duty to protect their buyer and take care to avoid a non-competitive result.