Ways mortgage lenders protect themselves
To acquire a mortgage loan, borrowers typically utilize a bank or private lender. These individuals will lend money to individuals with expectations of a certain amount back each month. Therefore, the lender depends on the borrower to make responsible moves such as submitting each payment on time. Furthermore, when the borrower defaults it falls onto the lender, including the foreclosure process which the lender has to sell the property to receive their money back. Therefore, it’s numerous risks associated with issuing mortgages which means lenders have to go to great lengths to protect themselves. There’s multiple tools and policies utilized by lenders to protect their selves when issuing loans. In this blog post, we explain ways lenders safeguard the assets to protect their capital.
Understanding Mortgage Lender Risks
When we think of risks associated with a mortgage, the main thought that comes to mind is defaulting and facing foreclosure. However, what’s not clear to the eye is the other risks associated with issuing a mortgage loan. Certain risks such as market conditions, like a property decreasing in value due to recently sold comps. Another potential risks for lenders is overall fraud such as deed fraud, where a scam artist attempts to take the home from the owner. These risks and others influence the borrowers loan terms and interest rates; that way a lender has the ability to properly protect themselves.
Key Ways Lenders Protect Themselves
There’s numerous ways and techniques lenders use to protect themselves. Some of these methods are stipulations after closing while others are requirements to meet prior to a loan being issues. Below are some common ways lenders protect themselves.
- Strict Borrower Loan Qualifations: Methods such as requiring a credit score of at least 620, while other lenders prefer a score of 680 to approve the loan. Another method is to examine the borrowers debt-to-income ratio which refers to their money owed compared to earned income. Furthermore, most lenders want to verify the borrowers employment & income, which can consist of W2’s or paystubs from a two year period.
- Loan to value: Lenders will ensure the value of the home’s higher then the loan amount. That way if the borrower defaults the lender can recoup their funds by selling the home.
- Property appraisals: As we mentioned above, the lender wants to ensure the homes value exceeds the loan amount. The best way to determine the homes value is by conducting an appraisal.
- Mortgage Insurance: Some ways lenders protect themselves, forcing the borrower to get private mortgage insurance. Furthermore with a PMI, the borrower pays extra as another stipulation for the lender to protect their capital incase of a mortgage default.
- Title Insurance: This concept is handled prior to closing. The title company will issue the insurance which protects the buyer from getting stuck with the prior owners debt and liens.
- Clear loan terms: Interest rates are clear as day before signing any agreements. Furthermore, payment penalties are reviewed incase of a missed monthly mortgage payment. It’s vital for the borrower to understand the terms and consequences of not fulfilling their part of the deal.
Common Misconceptions about Lenders
As humans we may assume things or be misguided when it comes to information we’re not familiar with. Therefore, just like any industry there’s misconceptations about lenders and the loans they issues. Below we cover a couple common misconceptations, that way borrowers understand the truth behind acquiring a mortgage from a private lender.
1. Lenders want foreclosure: Some individuals believe that lenders want you to pay interest rates with the borrower eventually defaulting on the loan. Which means the lender will then take control of the property and sell the home for it’s current value leading to the lender profiting from the house. However, this is simply not true since lenders prefer a successful loan and acquire their capital from the borrower fully paying the loan whether it’s a fifteen year mortgage or a 30 year mortgage loan.
2. Some people assume lenders only care about credit scores. Although credit scores are an important factor when getting approved for a loan, since lenders want to see responsible spending and borrowing it’s not the only part they care about. In addition to a credit score of at least 620, lenders care about steady employment and income. Along with no prior evictions, collections, and overall hard hits on your credit.
Loan Protection is Important for Lenders
When issuing a loan, loan protection is a vital aspect for a lender to protect themselves for losing money. Therefore, lenders have a long list of requirements before issuing the loan especially since the great mortgage collapse of 2008 when the requirements were lenient and many homeowners defaulted. Most lenders go off the same standards; a suitable credit score, a required downpayment, and little to no liens. If the risk outweighs the reward, the lender may reject the loan. Although most lenders go off certain requirements, some lenders can be more difficult then others. Therefore, when the time comes to apply for a mortgage loan, it’s suggested to speak with multiple lenders to find the best terms and interest rates. Not all lenders are equal, by shopping around the terms you can find the best fit for your mortgage needs and help reduce overall risk.