Oct 22, 2018
The Mortgage Loan Process in NYC Explained
What are some tips for the mortgage loan process you can utilize to ensure a successful close? We’ll let you in on some industry trade secrets about how the mortgage loan process really works in NYC and across the country, and how you can manage your credit and the mortgage underwriting process like an insider.
Managing Credit During the Mortgage Loan Process
It’s important to understand that credit documents have expiration dates. When a mortgage banker pulls your credit report, that credit report is only good for 120 days. That means if you got your credit pulled when you got a pre-approval letter in January, but went into contract in April, your credit report will likely need to be pulled again by your bank before closing.
Keep Your Finances the Same Until Closing
As a result of this, it’s important to make sure that your finances stay exactly the same before closing. Better yet, try to close sooner rather than later. It’s always preferably to close sooner to mitigate the risk of something changing in your credit report.
Don’t close any credit card accounts, even if you don’t carry a balance on it and wish to simplify your finances. If you do so and everything else stays exactly the same, your credit score will likely go down as you will be using a higher proportion of your available credit. This is a red flag for the credit bureaus as it signals stress in a borrower’s finances.
In a similar vein, do not open up a new credit card and rack up a bunch of charges, even if you are getting great terms for financing your purchase. Credit agencies will view this as a red flag and a signal that the borrower is desperate for credit.
If you have a credit card with a zero balance that you never use, it may be better to more evenly distribute your balances among multiple credit cards. That’s because your credit score is dinged if you use more than half of your credit line on any account. So if you have two credit cards each with a $10,000 credit limit, but you carry an $8,000 balance on one and a $0 balance on the other, you’ll get dinged. In this situation it’ll be better if you split the balance into $4,000 on each card!
Many people don’t realize this but your corporate credit card issued by your employer is often linked to your personal credit history. So be careful about spending a ton of money, perhaps on a business trip, on your company credit card during the mortgage loan process as it could negatively affect your credit score, causing you trouble if your bank needs to pull your credit again.
Be careful of shared credit accounts. For example, if you have a joint credit card with your spouse or a parent sponsors a credit card for their child in college, your credit can be impacted by the accounts of the other person on the account!
A clever trick to reduce your credit report loan balances is to pay off your credit card balance early, before the balance shows up on your monthly statement. Remember that you have the option to pay off your entire credit card balance at any time.
Not only will this reduce your loan balances on your credit report, it’ll also improve your Debt to Income ratio. Banks will only use the minimum credit card payment required as shown on your statement. However, why let that affect your DTI ratio if you plan to pay it off in full anyway?
Pro Tip: Don’t expect any changes to reflect immediately on your credit report. If you’ve just paid off your credit card balance, it can take a day or 2, or even up to 2 weeks for the changes to reflect.
How Does Getting My Credit Pulled Affected My Credit Score?
In general, your credit score will be negatively affected if your credit is pulled for different products in a short period of time. That means if your credit was pulled in the same month for a car loan, a credit card and a home mortgage, credit agencies will view this as a the borrower being desperate for credit.
However, if your credit is pulled multiple times within the same one calendar month for the same product, credit agencies will understand that you are simply shopping for the same product. So if you had multiple banks pull your credit in April because you’re shopping around for a mortgage, your credit will only get dinged as much as if you had your credit pulled by only one bank.
Mortgage bankers in NYC we’ve spoken with estimate that your credit will only get hurt a few points (“single digit points”) for a credit pull relating to a mortgage.
Pro Tip: Your credit will get dinged more if you have banks pull your credit multiple times over the course of the year. For example, if you had Bank A pull your credit in December, then had Bank B pull your credit in February, your credit score will be hurt because this did not happen within the same calendar month!
Credit Scores That Get the Best Mortgage Interest Rates
It’s important to understand that Fannie Mae and Freddie Mac have different minimum credit scores than that of banks. While Fannie and Freddie require a minimum credit score of approximately 620, your typical NYC bank lender will require a minimum credit score of 700 to 720. Banks will obviously have higher standards if a loan is not conforming and they have to hold it on their books vs selling it off to Fannie or Freddie.
Bank Relationship Pricing
However, interest rates will generally be better for non-conforming loans vs conforming loans. That’s because banks can utilize relationship pricing to subsidize rates for borrowers whose credit scores exceed their higher required minimums.
Banks generally understand that buying a house in NYC is one of the few major milestone’s in a person’s life, and they want to be a part of it!
From what we’ve heard from various mortgage bankers at the biggest lending institutions in NYC, a borrower will typically get the best interest rate for a jumbo (i.e. non-conforming) loan if their credit score is 740 or higher. For very high loan balances, the rate can improve incrementally if your credit score is 780 or higher.
However, it was interesting for us to hear that there is no difference if your credit score is 725 vs 735, or 790 vs 820. This means that the big New York banks really stick to their thresholds. This also means that if your credit score is on the cusp, i.e. your credit score is 740, you will really want to carefully manage your credit during the mortgage loan process in NYC.
Pro Tip: Many of the biggest banks in NYC will be able to lower your interest rate even further if you initiate a depository relationship with them. One big Wall Street bank recently told us that they can lower a borrower’s mortgage interest rate by 1/8% with a $50,000 deposit post close, and by 3/8% with a $200,000 deposit post close. Off the record, they’ve told us that even if you withdrew the money the day after closing, your better rate would still apply! Better yet, pay down your principal with the amount you deposited with the bank and ask the bank to “recast” the mortgage for you (i.e. restructure the amortization schedule).
How Banks Use Credit Scores in the Mortgage Loan Process
It’s important to understand that the free credit scores you find online will be different from the credit scores used by your mortgage broker or bank. That’s because the credit bureaus make money by having as many people and institutions use their services as often as possible. As a result, credit agencies issue different credit scores for the same person for different types of inquiries.
This means that a different credit score will be issued when pulling credit for a personal loan vs a mortgage vs a credit card vs a car loan. This is great for the credit bureaus so they can charge an approximately $10 fee each time!
Remember how there are 3 major credit bureaus in the US? As a result, your bank will receive 3 different credit scores for you. However, banks will only use the middle, or median, score during the mortgage underwriting process. That means they will not take an average of the three scores, and they will completely ignore the high and the low score.
If there are co-borrowers on a mortgage loan, the bank will use whoever has the lowest credit score among the co-borrowers. That means if there are 2 co-borrowers and one has a middle credit score of 730 and the other has a middle credit score of 800, the bank will use 730 as the credit score for the loan. As a result, it may not always be advantageous to have a co-borrower if their credit is worse than yours!
Pro Tip: It is possible to have two people on the title as co-owners, but to have only one person on the loan. The co-owner not on the loan will still have to sign the mortgage documents at closing, but won’t have to sign the loan note. Please remember that only the actual borrower of the mortgage can deduct mortgage interest on their tax return. Similarly for a co op apartment, the 1098 form is exclusively in the borrower’s name.
Which FICO Model Do Banks Use?
Banks currently use FICO Model 6, though some banks have already updated to FICO Model 9.Many banks are contemplating upgrading to the new FICO Model 9, so it’s important to understand the differences between the two as there are differences in how the bank interprets your credit history.
The older FICO Model 6 is very strict in terms of only looking at whether the borrower is paying their bills. This means you will be dinged if you disputing a $300 doctor’s office charge but are otherwise eminently financially qualified. Furthermore, a borrower that is paying only the interest on an interest only mortgage, but not paying down any of the principal, is viewed the same as a borrower who is paying down both interest and principal.
Obviously, this isn’t very insightful as the borrower who is able to also pay down principal should be more financially qualified as the borrower only paying the interest.
FICO Model 9 in contrast is more sophisticated. You will get a boost in your credit score if you are paying down your indebtedness and not merely servicing the interest. For example, you will get credit for voluntarily paying down the principal on an interest only loan, or paying off more principal than required on a 30 year fixed rate mortgage.
Furthermore, you won’t get dinged for de minimis charges in the context of an overall healthy credit report. More specifically, you will not get dinged for a small medical bill that you are disputing.
Avoid Delays from Form 4506
Banks today must verify that the tax returns you provided them match up with the tax returns the IRS has on file with you. As a result, you must provide your mortgage broker or bank a completed and signed Form 4506 which they can use to request a transcript of your tax returns from the IRS.
An important tip for the mortgage loan process in NYC is to fill out your personal information on Form 4506 exactly as it appears on your tax return. That means your address and name will have to be exactly the same in both places.
Our mortgage banker partners have seen rejected Form 4506’s because a borrower used Avenue vs Ave, or Street vs St, or included her middle initial when there was none on her tax return. We’ve even seen the IRS reject a Form 4506 because they felt that the signatures did not match.
Any bounce back from the IRS can result in days or even weeks of delay. The IRS receives a tremendous amount of paperwork requests from banks for verification of things like this these days. As a result, your revised Form 4506 may end up at the end of the queue if you have to submit it again because the address on Form 4506 did not exactly match the address on your filed tax return.
Why It Is Harder to Qualify for an Interest Only Mortgage?
An interest only mortgage is much harder to qualify for because both banks and coops will be analyzing your Debt to Income (DTI) ratio after the interest only period ends.
For example, if you are purchasing a property with a 7/1 IO ARM, that means your rate is fixed and usually at a lower rate for the first 7 years. The lower initial rates are the reason some borrowers go this route. However, it is still a 30 year mortgage that will fully amortize at the end of 30 years.
This means after the first 7 years when you only have to pay interest at an attractive starter rate, you will have to start making interest and principal payments.
Furthermore, these interest and principal payments will be higher than that of a 30 year mortgage because now you only have 23 years to fully amortize and pay off the mortgage.
It’s even harder to qualify if your interest only loan will become adjustable rate, or floating, after the interest only period. In this situation, banks and coops will look at what interest rates will be in 7 years in our example. Banks and coops might stress test the worst case scenarios to see if your DTI ratio is still acceptable.
Pro Tip: Some coop financial requirements will specifically prohibit adjustable rate mortgages.
How Interest Rates Work for Adjustable Rate Mortgages
Adjustable Rate Mortgage (ARM) interest rates are typically based off of 1 year LIBOR. This means the interest rate you will pay on an ARM when the interest rate becomes variable is 1 year LIBOR plus a spread. This spread is known in advance and can be as low as 1.5% and as high as 2.75% these days.
Our mortgage banker partners say it’s most common to see spreads of 2.25% or 2.5% as of this writing, though of course spreads and rates will vary so please check with your bank directly.
Let’s assume for example you have an ARM whose interest rate is currently floating (i.e. variable). Let’s assume the interest rate on this loan is 1 yr LIBOR + 2.25% during the floating portion of the loan term. The 1 yr LIBOR rate as of 4/25/2018 is 2.77%. So this means your total interest rate if calculated this week would be 5.02%.
Don’t worry about LIBOR being unusually high on the day your interest rate is set. Banks will typically use the average of the LIBOR rates for the 45 consecutive days prior to your loan becoming floating rate.
ARM interest rates are typically subject to minimum and maximum interest rates allowed during the term of the loan. Furthermore, if interest rates move dramatically, there is typically a maximum allowable change of typically 2% per year. These protections will come in handy if rates ever go back to where they were in the 1970’s and 1980’s when you saw mortgage rates of 20%!
Note: Interest rates for fixed rate mortgages are largely based off of the US 10 Year Treasury Note. The 10 Year Note is used vs the 30 Year Bond simply because it is more liquid!
What Exactly Are Points on Your Mortgage Loan?
A point is one percent of the loan amount. A point is an upfront, non-refundable fee or credit to the borrower.
Points are typically charged to the borrower to effectively purchase a lower interest rate for the life of the loan. For example, a bank might charge you 1 point upfront to lower your interest rate by 0.25% over the life of the loan.
Don’t worry, mortgage bankers today are not compensated based on whether you buy down your rate with points or not. Before the great financial crisis of 2007 to 2008, mortgage brokers and bankers were indeed often compensated for customers paying points.
Pro Tip: If you sign up for a buyer agent rebate, one of our partner buyer’s brokers can buy down your rate for you through what’s called an interested party contribution or seller concession towards closing costs.
It’s important to understand that banks only issue mortgages with interest rates in 1/8 percent increments. That means your mortgage rate can be 4% or 4.125%, but not somewhere in between.
So what happens if market rates for mortgages are somewhere in between? In this example, your bank can charge you a fraction of a point or even credit you a fraction of a point towards your closing costs to make your rate either 4% or 4.125%.
Pro Tip: Points paid by a borrower count as a prepaid finance charge and is deductible just like mortgage interest on the borrower’s tax return. You must deduct the points paid in the year that you paid. Learn more about NYC real estate taxes and the mortgage interest deduction in our guide!
How Are Home Equity Loans Priced?
Home equity lines of credit (HELOCs) are priced off of the prime rate. Please note that there is no official prime rate. A prime rate is simply the rate which banks lend to their best customers. Any home equity loan will specify exactly which prime they will reference, for example “the prime rate as published in the Wall Street Journal, U.S. Edition.”
Please remember that the mortgage interest deduction has changed with the Tax Cuts and Job Act of 2018, and now only the interest on the first $750,000 of acquisition indebtedness is tax deductible.
Interest on HELOCs are generally no longer allowed to be deducted, unless the proceeds are used to fund a “substantial improvement” of the property. With that said, a HELOC can count as acquisition indebtedness if it was taken out to actually purchase a property. In fact, the IRS just came out with a ruling last month that this $750,000 can cover both a mortgage and a home equity line of credit if both were used to finance the purchase.
How Do Banks Underwrite Borrowers for Mortgages?
The three fundamental criteria bank lenders use during the mortgage underwriting process are ability to pay, willingness to pay and the security of the asset.
The borrower’s ability to pay is largely determined by a review of the borrower’s assets, liabilities and income. Banks will focus on the ratio of the borrower’s monthly debt expenses vs the borrower’s monthly income. This ratio is called the Debt to Income ratio, or DTI ratio.
In addition to projected monthly housing expenses such as mortgage payments and maintenance or common charges, the bank will also include real estate taxes, home insurance premiums, car payments, student loan payments and credit card payments (i.e. other mandatory payments that show up on your credit report).
Your total monthly debt payments should not exceed 43% of your monthly gross income. With that said, some mortgage bankers have told us that the DTI ratio can sometimes be as high as 50% for mortgages that they plan to sell to Fannie and Freddie.
The borrower’s willingness to pay is largely determined by the borrower’s credit history and credit score. If you always pay your debts, this will be reflected in your credit history. If however, you have a reputation for reneging on your debts, this will almost certainly be reflected in your credit report. The banks have no obligation to loan to you if can’t demonstrate a prior willingness to pay off your debts and an ability to manage your finances properly.
The security of the asset, in this case the real estate being mortgaged, is largely determined by a property appraisal conducted by a randomly selected, third party appraiser. The bank wants a third party opinion on the value of the asset they are lending against so they don’t unwittingly loan more money than the property is worth, or lend too much money so that their margin of safety shrinks to an unacceptable level.
It’s important to realize that the bank will lend based off of the appraised value, not the contract price. This may be an issue if the borrower has purchased at a record valuation in the building and there are few recent comps to justify the price. As a result, if the appraised value comes in lower than the contract price, the borrower may have to put up addition equity to do the deal.
We’ll discuss in the next section how the appeal process for a property appraisal works in NYC.
Appealing an Appraisal
Congratulations on setting a record price per square foot sale price in the building, but the question now is can you get the listing to appraise at the contract price? An appraiser will generally look at comparable properties sold within the last 6 months in the same geographical area. If the property is unique or in a sparsely populated area and there are not enough comparable properties, appraisers are allowed to expand their criteria.
It’s important to understand that banks have an approved list of vendors that they must use, and that the specific appraiser for a property is randomly selected. This is in contrast to before the Great Financial Crisis of 2007 to 2008, when mortgage bankers threatened to not give future business to appraisers they individually selected if the appraisers didn’t give high enough valuations.
Right after new regulations were imposed post crisis, banks initially selected appraisers based on lowest cost. However, this turned out to be a flop because you ended up with a lot of appraisers from the suburbs appraising properties in Manhattan where they had no experience. Now appraisers are randomly selected, but only from pools of appraisers who specialize or have knowledge of a specific geographic area.
Appealing an appraisal is very difficult because the bank has to stick with the assigned appraiser. It is very difficult for the bank to choose a new appraiser to work on the deal unless they can point out that something illegal is going on. Therefore, it is extremely difficult to successfully appeal an appraisal unless you have cold hard facts to prove your case.
For example, if you can demonstrate that the appraiser forgot to view a room or appraised the wrong property, you may be able to successfully appeal the appraised value. Or perhaps you can demonstrate that the appraiser used a HDFC coop as a comp whereas the target property is a regular coop. However, anything less black and white will be very difficult to appeal.
Even if you dispute the room dimensions that the appraiser measured, the appraiser could easily say that they believe they measured it accurately, and if you wish for them to re-measure it with you present they could do it two weeks from now for $200. You see how difficult this can become?
A good tip is to always have the real estate listing agent or buyer’s agent present at the appraisal. It’s always nice to be able to hand over comps to the appraiser. Even though the appraiser is by no means obligated to use or agree with the agent’s comps, the appraiser will likely use them if the comps do make sense.
It’s nice to show the appraiser in contract comps if the market is trending up. Even though appraisers typically use just closed deals, they do have some leeway to use in contract deals if the market is moving. Appraisers will generally look for records of closed deals on public property websites like Realtor.com or StreetEasy and assume the data to be correct. Therefore, you can add genuine value to the appraisal process if you know that a certain data point is incorrect or not listed.
In terms of other upcoming changes such as proposed or ongoing construction that may block a unit’s view, there is a difference between rumor and actual construction. While an appraiser may not give credence to rumors or even news articles that a construction project is supposed to happen, an appraiser generally will consider actual construction taking place that may obstruct a target unit’s view.
Lastly, please realize that appraisers are people too and generally don’t want to create additional work for themselves. That means they will take the target property’s signed contract price as their starting point and will generally try to appraise the property at the contract price, especially if they think it is close. If however they think the valuation is very different from the contract price, they may feel a professional obligation to reveal what they think.
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Disclosure: Hauseit (https://www.hauseit.com) and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. The services marketed on Hauseit.com are provided by licensed real estate brokers and other third party professional service providers. Hauseit LLC is not a licensed real estate broker nor a member of any multiple listing service (MLS).
