Lender Requirements and Insurance

Lenders evaluate risk using qualification standards and insurance requirements. This section covers FHA, VA, USDA, and conventional loan requirements as well as LTV, PMI, and hazard insurance.

FHA Requirements

FHA loans are insured by the Federal Housing Administration. Key points include:

• Lower down payments than conventional loans
• Mortgage insurance premium (MIP) required
• Property must meet FHA condition standards

VA Requirements

VA loans are guaranteed by the Department of Veterans Affairs. Key points include:

• Often zero down payment
• No monthly PMI
• Funding fee required in many cases

USDA Requirements

USDA loans are for eligible rural areas and income-qualified buyers. Key points include:

• Often zero down payment
• Income limits apply
• Guarantee fee required

Conventional Requirements

Conventional loans rely on credit, income, assets, and debt-to-income ratios. Borrowers with high LTVs usually need private mortgage insurance.

Buyer Qualification and LTV

Loan-to-value (LTV) is the loan amount divided by the property value. Higher LTV means higher risk.

Example:

• Loan amount: $240,000
• Property value: $300,000
• LTV = $240,000 / $300,000 = 80 percent

Hazard and Flood Insurance

• Hazard insurance covers damage to the property.
• Flood insurance is required for properties in certain flood zones.

PMI and MIP

• PMI (Private Mortgage Insurance) applies to conventional loans with LTV above 80 percent.
• MIP (Mortgage Insurance Premium) applies to FHA loans.

Acronym Reference

Table: Lender Requirement Acronyms

Summary

Know which programs require insurance, how LTV is calculated, and the basics of FHA, VA, USDA, and conventional loans.

Underwriting Factors (General)

Lenders consider the "Four Cs":

• Credit - Credit score and history
• Capacity - Income and debt ratios
• Capital - Down payment and reserves
• Collateral - Property value and condition

Understanding these factors helps answer questions about buyer qualification.

LTV and Insurance Example

A buyer puts 5 percent down on a conventional loan. The LTV is 95 percent, so PMI is required. As the loan balance drops and the LTV reaches 80 percent, PMI can often be canceled.

Exam Application Check

If a question asks which loan requires a property to meet stricter condition standards, the answer is FHA.

Insurance Cost Example

A buyer with a 90 percent LTV on a conventional loan will usually pay PMI until the loan reaches 80 percent LTV. FHA loans require MIP regardless of LTV.

Exam Application Check

If a question asks which loan uses MIP, choose FHA. If it asks which loan requires PMI, choose conventional loans with high LTV.

Debt-to-Income (DTI) Ratios

Lenders evaluate how much of a borrower's income goes toward debt. A lower DTI generally improves approval chances. The exam may ask how DTI relates to capacity and qualification.

Insurance and Escrows

Lenders often require escrow accounts to collect taxes and insurance. This protects the lender by ensuring property taxes and hazard insurance are paid.

Exam Application Check

If a question asks which insurance protects the lender against default on high-LTV conventional loans, the answer is PMI.

Down Payment Sources and Reserves

Lenders often require documentation of down payment sources and reserves. Acceptable sources can include savings, gifts (with documentation), or approved assistance programs.

Reserves are funds available after closing and can strengthen a borrower's approval.

Exam Application Check

If a question asks which factor demonstrates capacity, focus on income and debt ratios. If it asks which factor demonstrates capital, focus on down payment and reserves.

Loan Programs in Practice

FHA and VA loans have occupancy requirements, meaning the borrower must typically live in the property. Conventional loans are more flexible for second homes and investment properties.

Exam Application Check

If a question asks which loans are typically owner-occupied programs, the answer is FHA, VA, and USDA.

Insurance Review

PMI protects the lender if the borrower defaults. It does not protect the borrower. MIP functions similarly for FHA loans.

Exam Application Check

If a question asks who PMI protects, the answer is the lender.

Credit and Qualification Basics

Higher credit scores generally lead to better interest rates and loan terms. Lenders also review employment history and stability.

Exam Application Check

If a question asks which factor relates to creditworthiness, focus on credit history and score.

Example: DTI Calculation

If a buyer has $6,000 in gross monthly income and $2,100 in total monthly debt, the debt-to-income ratio is 35 percent. Lower DTI generally improves approval chances.

Example: LTV and Down Payment

If a home costs $300,000 and the buyer puts down $30,000, the loan amount is $270,000. LTV = $270,000 / $300,000 = 90 percent. This would typically require PMI on a conventional loan.

Exam Application Check

If a question asks whether PMI is required at 90 percent LTV, the answer is yes for conventional loans.

Pre-Approval vs. Pre-Qualification

Pre-qualification is an informal estimate. Pre-approval is more formal and based on verified documents. Sellers generally treat pre-approval as stronger.

Exam Application Check

If a question asks which is more reliable, the answer is pre-approval.