Chapter 13

Loan Origination, Processing, and Closing

I. Origination is just the creation of new loans (which we see in a number of
chapters in the text)
II. Processing involves a number of steps
A. Taking and Analyzing the Application. Steps include:

Asking the borrower about his/her income, wealth, credit history; also
features of the property that serves as security

Verifying this information with third parties:

Banks, employers, credit bureaus

Applying for insurance (FHA or PMI) or VA guarantee if the

downpayment is less than 20%

Underwriting (risk analysis, per Chapter 12)

B. Having an Appraisal Done based on the three approaches to value (home

lenders always want to see the cost and sales comparison approaches)

Since January 1993, appraisers have had to be licensed or certified by

their state governments to do appraisals in connection with federally
related transactions (such as loans from insured lending institutions)

FNMA and FHLMC guidelines also call for purchasing loans only if the
appraiser was state licensed or certified

Completed by an outside fee appraiser, or by a staff appraiser for the

originating institution (less likely today than in the past)

Reviewed by the lender and by regulators (well, sort of, anyway)

III. Closing is the process of finalizing the documents and distributing the
documents and money.
The closing takes place at a meeting where the buyer and seller, their brokers
and attorneys, and the lender exchange money and documents to bring about the
conveyance of a bundle of rights from seller to buyer. The closing is organized
by the lender or one of the attorneys. In our area it is typically the lender, who
computes all relevant dollar amounts and reports the transaction to the IRS.
The sale contract should specify a date and place for the closing. Enough time
should be allowed so that the title search, inspections (appraiser, termite), and
document preparation (mortgage, deed) can be completed. The process used to take
6 weeks or so; now its down to 3 or 4 as lenders have gained better access to
computerized information (e.g., credit histories), and it may fall to a matter of days
or even hours as technology improves.
If the contract does not contain a time is of the essence clause, the closing may
take place a reasonable time after the stated date without any penalty to the party
causing the delay.
IV. What is exchanged at the closing?
A. Cash is paid to the seller, normally in the form of a cashiers check from the
buyers lender (in this area, the closing typically takes place at the lenders office).
B. Deed is given to buyer. It is prepared by the sellers attorney, with some of the
language dictated by law, some by the sellers wishes or bargaining strength (e.g.,
type of deed), and some reflecting the buyers wishes (e.g., taking title as joint
tenants). It is important that everyones name be spelled correctly. The deed should
convey marketable title (no major questions or defects) to the buyer.
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C. Affidavit of title is given to buyer signed statement that no activity (e.g.,

bankruptcy or potential liens) that might endanger the title has occurred since the
title search was completed. Lien waivers may be required.
D. Sellers mortgage is released, or discharged the attorney or lender who
organizes the closing should obtain information from the sellers lender(s) on
the amount owed on the sellers loan(s) as of the date of closing (these balances
reduce amount payable to seller), along with any overages in impound accounts that
should be a credit to the seller (these increase amount payable to seller). The
buyers lender will not provide a loan until all money owed by the seller has been
repaid. The two lenders must cooperate, or the closing process can be delayed.
E. Buyer issues note and mortgage to his/her lender; that lender provides truth-inlending disclosure to the buyer/borrower.
F. Homeowners insurance documents, if buyer takes over sellers policy.
G. Title insurance policies typically the buyer pays for lenders policy, seller pays
for buyers policy.
H. Receipts or bills for property tax payments (recall that prior years taxes are
typically prorated based on local custom).
I. If new construction, a certificate from local government stating that property is fit
for occupancy (some Illinois communities require such a statement even for older
properties).
J. Termite inspection report is given to buyer and lender.
K. Commissions are paid to brokers from sale proceeds.
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L. Buyer should receive bill of sale for any personal property purchased with the
real estate.
M. For income-producing properties, copies of leases, maintenance contracts, and
employee records should be provided to buyer by seller.
After the closing, the new deed and mortgage (and the release of the sellers
mortgage(s) are recorded.

What are the costs paid at closing? Some examples are:

Debits for buyer: downpayment, loan application fee, discount points, mortgage
insurance, credit report fee, premium for lenders title policy, recording fees for deed
and buyers mortgage.
Debits for seller: prorated property taxes, premium for buyers title policy,
attorney fee for document preparation, brokers commission, recording fees for
release(s) on sellers mortgage(s), transfer tax paid to state and county ($1.00 to
state of IL, 50 to county higher in Cook for every $1000 of transaction price,
rounded to nearest $500.) [You can check the state tax stamps on a deed to get a
close estimate of sale price; $120 in tax means the sale price was about $120,000.]

V. Proration
At closing, there may be several accrued (still owed by seller) or prepaid (already
paid by seller) expense items. Prepaid items could include insurance premiums,
homeowner association dues, or utilities (especially heating oil) already paid for,
along with property tax paid for in advance. In Illinois, however, property tax is

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paid in a later year, so property tax typically is an accrued item that must be
prorated at closing.
Different methods for prorating exist; we will concentrate on the actual days in
year method typically used in practice (although the license exams in Illinois
assume monthly proration, with twelve 30-day months).
For example, 2012 property taxes of $2,400 to be paid in June and September of
2013. Closing is held on March 31, 2013. So at closing, seller should pay to buyer:
$2,400 for 2012 plus 90/365 of $2,400 = $591.78 for 2013; total of $2,991.78.
Note that seller is generally to be liable for tax on the day of closing. Note also that
2013 taxes are estimated to be the same as 2012s, but the actual tax could
be higher. In the typical transaction, buyer just accepts the loss. (One mitigating
factor is that the buyer gets to collect a few months interest on the tax prepaid by
the seller at closing.)
VI. Real Estate Settlement Procedures Act (RESPA) [1974, amended 1975]
This act was designed to 1) curb lender abuses (it did), 2) reduce settlement costs (it
didnt)
The law applies when any lender that is federally insured, or that lends more than $1
million per year, makes a loan on a 1 4 family owner-occupied property. The
lender is required to:

A. Provide potential borrower with HUD informational pamphlet on closing costs.

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B. Give a good faith estimate of closing costs when the loan application is
completed, and give an exact figure one business day prior to closing. If actual cost
ends up being higher than the estimate, usually a party other than the borrower (the
lender or appraiser, for example) must pay the difference.
C. Collect only a small cushion over amounts actually needed in impound
accounts.
D. Provide a copy of the Uniform Settlement Statement to all concerned parties.
The worksheet we look at in class is not the actual settlement statement, but it does
contain much of the same information.

VII. Also discussed in this chapter The Mortgage Banking Process

Mortgage bankers originate and sell loans (or purchase loans and repackage them
into securities). They may or may not retain the right to service the loans. Large
commercial banks (sometimes their subsidiaries) and major Wall Street firms are
actively involved in mortgage banking.
Mortgage bankers differ from mortgage brokers in that bankers own the notes for a
short period of time, whereas brokers are just middle parties (similar to the case of
investment bankers vs. stock brokers)
Mortgage banking came about in the late 1800s / early 1900s as a means of
financing farm loans. Early mortgage bankers originated farm loans and then sold
them to insurance companies and other big investors.

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These institutions got into residential lending in a big way in the 1930s, originating
FHA loans (banks and S&Ls initially did not get heavily involved in making FHA
loans).
Where do mortgage bankers get the money to lend?

Issuing commercial paper

Obtaining loans from commercial banks

Mortgage bankers that finance their operations through bank loans typically are
smaller operations that warehouse loans for a short time, and then resell as quickly
as possible.
A problem faced by those that borrow from commercial banks is the need to
maintain compensating balances (although impound accounts may provide for part
of this requirement).
Larger operations can access the commercial paper market, and they are likely to
have arranged to sell the loans before originating them.
Sources of revenues for mortgage bankers:

Major source is origination fees

Also, servicing fees (both on loans originated and sometimes on others as well
there are economies of scale in servicing operations)

Mortgage bankers also can make money on the spread between the interest rate paid
and the interest rate received on the loans temporarily held, or by realizing gains on
the sale of the notes.

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