When lending money to borrowers for home mortgages, how do you think banks minimize the risks of defaults in payment? Just imagine how much of a loss they will incur if a handful of borrowers fail to make payments on time. To prevent this from happening, what they do is use some techniques in managing default risks.

An Introduction to How Banks Manage Default Risks

In the eyes of the bank or the lending institution, all borrowers have an equal opportunity of getting approved for the loan that they are applying for. However, there are things that need to be done on their end in order to manage risks. Remember that as the lending institution, it is their capital, business and profit which is at high risk.

Just imagine what will happen if they shell out thousands of dollars to a homeowner whose mortgage loan got approved. If the borrower defaults on the loan or fails to make any payment at all, they will have to shoulder the financial losses – despite the fact that they can actually claim the borrower’s home which was placed as collateral.

This is precisely the reason why they need to enforce a loan approval process which will determine exactly how high a credit score a borrower should obtain. The amount of down payment that a borrower needs to shell out; the interest rate that they will apply; and all the other conditions regarding the home loan will also be determined during the loan application process. As a result, the lending institution will better manage default risks.

3 Factors to Consider when Managing Default Risks in Home Mortgages

Now that you already have an idea about how financial institutions play down the risks involved in lending money to a borrower, here is a list of the factors that they consider during the loan application process:
1. The borrower’s credit score.
Your credit score is actually the first thing that banks and lending institutions consider once you submit your application for a mortgage loan. More often than not, they clients obtaining a low credit score, bad credit score or no credit history at all as being high-risk borrowers. This is precisely the reason why they charge more for low credit score individuals.

Although it does not necessarily reduce the risk, they are basically charging borrowers for the future interest income which would not be realized should the person default on the payment.

2. The down payment and interest rate.
As mentioned earlier, it is individuals with a low credit score who will be slapped with higher interest charges – simply because they are considered as high-risk borrowers. Down payments, on the other hand, usually equate to the present value of future interest payments.
3. The default, prepayment and reinvestment risks.
Management of risks on default, prepayment and reinvestment involves the lender asking for a higher down payment.

As you can see, it almost seems like a must for financial institutions to charge a higher interest rate for low income or low credit homeowners – because it is a way to insure their failure to pay and increase the prepayment through default and refinancing.

By following a certain set of rules, these financial institutions will be able to establish more solid business practices. As a result of their default risk management, they are able to serve clients better and give more and more homeowners the chance to have their very own homes through mortgage loans.

Rob K. Blake, refinance expert and author, educates mortgage shoppers on finding local providers by state like Vermont Mortgage Brokers and Lenders and provides reviews of national companies like ABN AMRO Mortgage.

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How does SBA financing work?  First of all, it is very similar to regular commercial bank financing.  In fact, one of the biggest misperceptions out there is that the SBA finances transactions themselves.  This is not the case.  Loans are financed by banks and the SBA guarantees the bank in case the borrower defaults. 

So essentially, the SBA is just making a promise that they will reimburse the bank if the borrower fails.  It’s basically an insurance program for the bank.  Because of this guarantee, banks will make loans to borrowers that they would not consider, by a long shot, if they did not have the guarantee.  Aggressive features of SBA finance include 90% financing… (Most banks won’t go beyond 60% now a days), considering goodwill of businesses as collateral, financing start ups, etc. 

Because the SBA basically just guarantees the bank, borrower should remember that being declined by one bank does not mean that there transaction isn’t doable via the SBA programs.  Within SBA financing, there is a wide degree of what one bank to another will consider credit worthy.  It is also critical to remember that banks have their own problems.  You may have a solid loan request and the bank may decline it because they have exceeded their capital reserve limits or have low liquidity, etc. 

If you are declined it is best to find out exactly why, so that you can be better prepared to deal with it with the next bank, broker or lender. 

How To Apply For SBA Financing

In general you should first do phone interviews, than send in required documentations.  On the phone interview you want to discuss the overall transaction, including its strengths and weaknesses.  If there are major issues with the request you should mention them, in a positive light, and see if they might have a solution to it.  Don’t bother trying to leave anything hidden, as the underwriters will discover it later. 

Also, try to determine their level of activity, i.e. are they really funding loans?  Many banks are still taking loan requests yet aren’t funding loans.  Why?  There’s a variety of reasons, like lack of communication from upper management to loan officers, denial, trying to not lose face in the market place, etc.  But it’s your money and time that is on the line, so you need to figure this out.  One way to do this is get third party referrals from other business owners, your CPA’s, attorney or of course seasoned commercial mortgage brokers. 

Assuming you think the bank is active, and that they like your loan request you will need to get to work and provide the necessary paper work.  This is extensive and time consuming, though there is no way around it.  You fill out the forms and provide the needed documentation or you go nowhere. 

After the bank receives the package from you they normally will issue you a term sheet within 5 days or so which spells out the proposed loan.  At this point your deep into the process and need to make a decision to go with that bank or not.

SBA financing is still viable… they continue to close as the rest of the commercial mortgage market falls apart.  Business owners that need to buy commercial real estate or refinance their property should give SBA financing serious consideration. 

Jeff Rauth is President of Commercial Finance Advisors, Inc. They close SBA and other commercial real estate loans between $400,000 – $5,000,000 nationwide. Reach him at 248 885-8797 or at SBA 7a Loans or SBA Business Loan or SBA Lenders

Article Source:http://www.articlesbase.com/mortgage-articles/how-sba-financing-works-1428729.html

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