Because
a new home is probably the largest and most important purchase
you'll every make, our Mortgage Information Desk will provide
you with the information you need to make wise choices.
Mortgage Information Desk: Underwriting
After the information on the loan application has been
validated, the value of the property has been confirmed,
and the title search has been completed, the loan is ready
to be underwritten. Usually, a trained professional reviews
all of the information, analyzes the credit worthiness of
the borrower, and renders a decision on the loan request.
Increasingly, much of the analytical tasks of underwriting
is performed by technology through artificial intelligence
and use of databases. There are generally secondary market
underwriting guidelines, but many variables are considered
in the analysis. The following outlines some of the basic
areas and items considered in the process.
Monthly Housing Expenses and Total Debt Obligations
One of the first things an underwriter determines is the
borrower's proposed monthly housing expenses and total monthly
debt obligations.
- Housing expenses: These include the
monthly principal and interest payments that are stipulated
on the mortgage note. In addition, the monthly housing
expenses include a monthly amount for the property taxes
and hazard insurance (1/12 of the annual taxes and insurance).
There may be other expenses, such as condominium fees,
homeowners fees, special assessments, etc., that are included.
- Monthly debt obligations: These include
monthly credit obligations, such as installment payments,
revolving charge cards, or other borrower obligations
that will continue longer than 10 months. Usually, 5%
of the current balance of a revolving charge account is
used for the monthly payment.
- Total monthly debt obligations: This
combines the monthly housing expenses and monthly debt
obligations.
Monthly Income
One of the most important components of the loan underwriting
process is determining the borrower's monthly income. The
income of all borrowers and co-borrowers is included in
the calculation. The income can be derived from several
sources, but it must be supported by historical documentation
and have a high likelihood of continuation. The following
outlines the types of income that are used and the means
to support them:
- Salary: Income derived from any kind
of salary, whether monthly, weekly or hourly is acceptable.
Two year employment history is usually required.
- Commission and bonus: Commissions
and bonuses can be used for income. The underwriter will
average the last two years of income shown on federal
income tax returns and the year-to-date earnings from
the written verification of employment or paystubs.
- Self-employment income: Generally,
the underwriter will average the income derived through
self-employment for the last two years from the applicant´s
federal tax returns and the year-to-date earnings from
a profit and loss statement on the business. Usually,
underwriters will take into consideration the income trends
in the business, as well.
- Other income: Other income can be used
for loan qualification. Income derived from rental properties,
interest, dividends, pensions, and social security can
be used.
Income to Debt Ratios
After determining the monthly income of the borrower and
any co-borrowers, the monthly housing expenses and the total
monthly debt obligations, the underwriter calculates two
ratios that are helpful in the loan underwriting process.
- Primary Housing Expense (PHE)/Income Ratio(I): This
ratio is the result of dividing the housing expenses for
the proposed loan by the monthly income of the borrower(s).
For example, if the primary housing expenses are $1,000
and the total monthly income is $4,000, the ratio will
be 25% ($1,000/$4,000 = 25%).
- Total Obligations (TO)/Income Ratio(I): This
ratio is the result of dividing the housing expenses for
the proposed loan plus the borrower(s) other monthly credit
obligations by the monthly income of the borrower(s).
For example, if the total obligations of the borrower
is $1,400 ($1,000 for housing expenses and $400 for other
credit obligations), the ratio would be 35% ($1,400/$4,000
= 35%).
Qualifying ratios are only one component of the underwriting
process and many other variables are considered in the
final decision. Ratios are used as guidelines and can
frequently be much higher than guidelines.
Funds to Close
When the proposed loan is being used to finance the purchase
of a home, underwriters will determine the source of funds
for the down payment and closing costs. The following are
acceptable sources of funds for closing:
- Cash: Cash in any depository institution
or investment company is acceptable.
- Stocks, bonds, mutual funds, etc.:
Cash equivalent investments are acceptable forms of funds.
They can be validated through statements from investment
companies for the last two months.
- Sale of existing property: Many times
the source of funds for the down payment on a home comes
from the equity in a property that will be sold. The sales
price of the property being sold is indicated on the loan
application and any existing loan is verified on the credit
report or through a verification of previous mortgage
- Gift from family members: Gifts from
family members for the down payment and/or closing costs
are acceptable so long as there is no requirement for
repayment. Some loan programs limit the amount of gift
funds allowed.
Credit Analysis
Another very important part of the underwriting process
is determining the creditworthiness of the borrower. Loan
underwriters review the borrower's credit report to find
evidence of debt repayment behavior. Some of the important
areas that are reviewed are:
- Past and existing mortgage debt: The past repayment
history on mortgage debt can be a good indication of a
borrowers attitude toward mortgage obligations. A good
payment history on mortgage debt is very important in
the credit analysis.
- Generally, payments received 30 days past the due date
are reflected in the credit report as late. Lenders vary
in strictness, and some may not allow any late mortgage
payments, while others will allow 1 or 2 in the last two
years if there is a good explanation.
- Installment and revolving credit: Other items on the
credit report can also indicate a borrower's attitude
toward credit obligations. Credit reports indicate the
outstanding balance, current balance, and terms of payment
on the borrower´s revolving and installment debt.
Underwriters review these credit obligations to determine
the borrower's patterns of credit use and repayment behavior.
Revolving credit encompasses department store and bank
credit cards. Installment credit encompasses longer term
credit with structured payment plans, such as car loans.
Generally, underwriters are not concerned over isolated
and minor slow payments indicated on the credit report.
- Collections, repossession, foreclosures and bankruptcies:
Credit reports also indicate public records such as collections,
repossessions, foreclosures, and bankruptcies. Though
these items may indicate past credit problems, they sometimes
have valid explanations. Underwriters may require a letter
of explanation on items noted in the public records. Many
times consumers have re-established credit and have an
excellent payment history on their current obligations.
Underwriting the Appraisal
Generally, underwriters are not professional appraisers
and do not re-appraise the property. They will review the
appraisal to assure that it meets the requirements of the
investor and sometimes request additional information to
substantiate the value. They may request that a second appraisal
or review appraisal be performed. If they believe that the
value can not be substantiated, a review appraisal can be
completed from a site inspection or review of the written
appraisal. In both cases, another professional appraiser
will perform the review.
Compensating Factors
The underwriters consider many variables in their analysis.
No two borrowers have the same credit and income profiles
and underwriters use all of the information in the loan
file to render a decision. Many times, borrowers fall outside
the guidelines, but have strong compensating factors that
reflect low credit risk. Some compensating factors are history
of savings, long-term job stability, history of making monthly
credit payments that equal or exceed the proposed payments,
a substantial down payment, or a large cash reserve after
the close of escrow.
Final Credit Decision
After the underwriter has reviewed the entire loan package,
there can be four outcomes:
- Approval: If the loan is "picture
perfect" and the underwriter has no questions, the
loan will be approved with no conditions.
- Approved with conditions (the most common response):
There are two types of conditional approvals:
(a) If the underwriter needs additional documentation
before a final credit decision can be made, a "prior-
to document" conditional approval will be rendered.
In essence, the loan documents will not be prepared until
the condition has been satisfactorily met. An example
of a "prior to document" condition could be
a pay stub to validate the borrowers income. (b) If the
loan can be approved, but a condition must be met prior
to closing, a "prior to funding" conditional
approval will be rendered. In this case, the loan documents
will be prepared and sent to the closing agent, but the
lender will not fund the loan until the condition has
been met. An example of a "prior to closing"
conditional approval could be proof of sale of existing
home where the equity will be used as the down payment.
- Suspended: Sometimes the underwriter
will be unable to make a decision on a loan file because
it is either incomplete or there are many unanswered questions.
In these cases, the underwriter will ask for additional
information from the borrower before an underwriting decision
is made. An example of a suspension may be large gaps
in the borrower's previous employment history and no tax
returns to indicate the place of employment.
- Denial: Underwriters will be unable
to approve a loan if the loan file has substantial deficiencies
and does not meet the minimum standards of the lender
or the lender's secondary market investors. Most lenders
require that a second underwriter review the loan package
before a final denial is communicated to the borrower.
Denial letters with the reason for denial are sent to
borrowers within 3 days of the final credit decision.
Underwriting criteria can be different among lenders and
a borrower may find other acceptable alternatives in the
market place.
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