Loans have become an integral part of modern capitalism, giving you the money you need to make large purchases, start a new business, or follow your dreams. Developing a better understanding of loans and how they work can set your mind at ease and help you get the money you need, whenever you need it. Read on to learn more about loan origination and its processes.
Understanding Loan Origination
Loan origination broadly refers to a multi-step series of processes that every individual has to go through in order to get many types of personal loans, though it mainly applies to mortgage and home loans. Generally, the loan origination process involves all the steps from submitting a loan application to either disbursing the funds or rejecting the application. Everything after the disbursal of funds is covered by loan servicing.
During the loan origination process, potential borrowers have to submit various pieces of financial information and documentation to mortgage lenders. This can include:
- Tax returns
- History of payment
- Credit card information
- Bank statements
- Bank balances
- Credit reports
Loan originators use this and other information, particularly credit reports, to determine if a potential borrower is eligible for a loan. The overall loan process is lengthy and involves several steps, including the loan application, screening, negotiations, finalization of the application, and the actual loan approval.
The Role of the Loan Originator
All loan origination is mainly handled by the loan originator, from the application to the granting of the actual loan funds. Loan originators can be independent or work for a lender. This is good to keep in mind as loan originators who work for banks are mainly worried about keeping the bank’s best interests at heart, which may or may not line up with your personal needs.
Independent loan originators often cater much more to your personal needs, helping potential borrowers choose the type of loan and directing them to the lenders that offer the best deals. Banks and other traditional lenders do not usually deal with hard money loans.
This is the first step in the loan origination process. During this step, the loan officer meets with the borrower, who provides all the basic data and information related to their income and the property they hope to cover with the loan. This includes anything that can help substantiate your current income, your employment status, and your basic finances.
Usually, during pre-qualification, the loan originator has enough information to determine the type of loan that the borrower may qualify for. There are generally three different types of loans:
- Fixed-rate loans – These loans have the same interest rate for the entire life of the loan.
- Adjustable-rate mortgage (ARM) – Adjustable-rate loans have interest rates that fluctuate based on an index (similar to treasury securities).
- Hybrid loans – These mix both fixed-rate and adjustable-rate loans. Most hybrid loans start as fixed-rate loans before converting to adjustable rate loans
Some potential borrowers may also be eligible for special loans funded by government entities, like the Federal Housing Authority. Current and former military members and their families may also be eligible for loans from the Department of Veteran Affairs. These are generally more unconventional and are often structured to make the whole process of purchasing a home easier.
For example, some of these unconventional loans may have a small or nonexistent down payment, while others may feature low qualifying ratios (a ratio used by lenders to approve potential borrowers for a loan).
During the pre-qualification step, the potential borrower also receives a list of all the documents and information necessary to complete the loan application. This can be extensive and involve a variety of different forms and documentation, including:
- The contract for purchase and sale
- W-2s and other income tax forms
- Profit and loss statements for self-employed individuals
- Regular bank statements
The lender can also request further documentation as you go if necessary. You will also be required to include mortgage statements if you the loan you are asking for is a refinance of an existing mortgage.
The Loan Application
After pre-qualification is the actual loan application. During this stage, the potential borrower fills out a written application for the loan and turns in all of the necessary documentation that was requested during the pre-qualification stage. The loan application should comprise basically all of the information a loan company needs to make a decision about either rejecting you or providing you with the funds that you need.
During this time, the loan officer will also go over the different loan options that are available to you and help you choose the one that most suits your personal and financial needs. The loan officer will complete all the legally required paperwork on their end to process the loan. You will also likely work with a loan processor, a professional who assists the loan officer but also works with you to double check and verify all your documentation before the application is sent forward to the underwriter.
Screening and Negotiation
During the screening process, the loan officer will verify the potential borrower’s credit score, which essentially quantifies how you have managed and repaid previous loans, including student loans, car payments, and home equity loans. Your credit score gets worked into your income, but it more importantly helps the loan officer predict how well you can pay back loans in full and on time. Screening also involves determining your income status and finances, all to figure out if you qualify for a loan.
However, this generally does not apply to hard money loans, which operate based on the value of the property and not the credit worthiness of a potential borrower. Hard money loans have lower loan-to-value ratios as the property itself is used as protection against default.
This may be followed by a negotiation period. This depends mainly on how the lender approaches your loan and your financial status, but you may be able to negotiate loan terms that are favorable to you that are still fair to the lender.
At this point, the loan application and documentation are out of the potential borrower’s hands. All of the paperwork completed in the previous steps is filed and passed through several departments, including documentation, processing, and automatic underwriting programs, for approval. Many files are passed to an underwriter, who manually approves or rejects the paperwork.
Once your loan has been approved, the loan officer will schedule a closing, during which time they will get an appraisal for the real estate property, request any insurance information, and finally send the loan file to the loan processor. The processor may follow up with you and request additional information or documentation to review the loan approval.
Understanding Origination Fees
The origination fee is the upfront amount you pay to the lender to process a new loan application. This fee ultimately acts as compensation for working with you and putting the loan in place. Origination fees normally act as percentages of the total loan. For example, in the United States, origination fees on mortgages are usually between 0.5 percent and 1 percent of the loan.
Consider origination fees as an analog to a commission. Customers with higher loan amounts will try to negotiate lower origination fees. Furthermore, because all loans generally require the same amount of work from the lender, some lenders may have a higher percentage origination fee on lower loans.
The origination fee is representative of a lender’s primary means of getting paid for their services. Prior to this, during the late 90’s to mid-2000’s, lenders earned large origination fees on top of yield spread premiums for selling loans with higher interest rates. Some lenders charged origination fees up to 5 percent of the loan amount.
However, after the financial crisis in 2008, the government began to place more restrictions on how lenders received their compensation, and many lenders pulled back on their origination fee practices. Today, with borrowers better informed about going rates, origination fees are less than 1 percent of the loan amount on average.
Like many aspects of a loan, origination fees may be negotiable depending on the lender. However, understand that lenders should not be expected to work for free. Negotiating lower origination fees may involve giving something up to the lender, which most often means accepting a higher interest rate on your loan.
For the lender, this essentially means earning more commission from yield spread premiums instead of their origination fees. This can get tricky as, most of the time, the borrower is better off paying the origination fee, which will almost always be lower than the interest that gathers over time.
Established in 2006, Del Toro Loan Servicing offers a full spectrum of premier services for private lending professionals. With a team of experts and professional partnerships, we are dedicated to providing personalized service that is tailored to your needs and the needs of your company. If you have questions about loan origination or need help with your loan servicing needs, please contact us today or read our frequently asked questions to learn more.