Mortgage Loan Underwriting Process & Guidelines
When you apply for a mortgage, your lender will complete the underwriting process. The mortgage loan underwriting process is intimidating, but lenders have pretty good reasons for undertaking the process. Suppose your best friend hits you up for a loan. If your pal wants to borrow five or ten bucks until payday, that’s no big deal. But if your acquaintance needs five or ten thousand dollars for a decade or so, you’ll probably analyze the odds of getting repaid six ways to Sunday before parting with a nickel!
Good lending institutions are even more careful with their depositors’ funds. They employ professional underwriters, who evaluate the degree of risk involved in loans that the lenders have been asked to make to prospective borrowers. In other words, underwriters tell the lender how much risk is involved in lending money to you. If they determine that you’re too risky, chances are you won’t get the loan. The mortgage loan underwriting process will be similar regardless of your lender but it does vary somewhat from lender to lender.
- Most lenders comply with underwriting guidelines of two institutions, the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae). These lenders sell their loans on the secondary mortgage market to Freddie Mac or Fannie Mae, who then resell the loans to investors such as insurance companies and pension funds.
- Portfolio lenders, who keep loans they originate instead of selling them in the secondary mortgage market, may have more flexible underwriting standards, but they may have higher rates or only offer adjustable rate mortgages.
Just because one lender turns you down doesn’t mean that all lenders will. If you’re having trouble getting a loan approved, head for a portfolio lender in your area. In addition to your own interviewing of lenders, a good mortgage broker can help you identify more flexible (portfolio) lenders.
Traditional underwriting process
Underwriting standards can vary from lender to lender, because the underwriters who examine loan applications are flesh-and-blood human beings, not machines. Two underwriters can evaluate the exact same loan application and reach different conclusions (regarding the degree of risk involved in making the loan), because each interprets the traditional underwriting guidelines differently.
To get a mortgage, you must give a lender the right to take your home away from you and sell it to pay the balance due on your loan if you:
- Don’t make your loan payments
- Fail to pay your property taxes
- Let your homeowners insurance policy lapse
The legal action taken by a lender to repossess property and sell it to satisfy mortgage debt is called a foreclosure. Lenders detest foreclosures. They’re typically financially detrimental and emotionally debilitating for everyone involved in the transaction, and they generate awful public relations for the lender. And, if a lending institution has too many foreclosures, state and federal bank regulators begin questioning the lender’s judgment.
Lenders constantly fine-tune the way they evaluate mortgage applications in search of better screening techniques to keep borrowers — and themselves — out of foreclosure.
Here are the primary factors that lenders used as part of the underwriting process to assess prospective borrowers’ creditworthiness:
- Integrity: One of the first things a loan processor does after you submit a loan application is order a credit report. Surprisingly, blemishes on your credit record aren’t always the kiss of death. Even with the blemish of a bankruptcy or foreclosure in your credit history, however, you’ll get favorable consideration from lenders if you established a repayment plan for your creditors. That commitment demonstrates integrity. Conversely, people who’ve skipped out on their financial obligations are treated like roadkill.
- Income and job stability: Lenders don’t want you to overextend yourself. They know from past experience that the number-one cause of foreclosures is borrowers spreading themselves too thin financially. Most lenders ask for your two most recent IRS W-2 forms to establish your gross annual income plus the last 30 days of pay stubs as proof that you’re still employed. Some lenders are more lenient than others are when they see that a prospective borrower has a history of job-hopping. All lenders, however, must be certain that you have a high likelihood of uninterrupted income. If you don’t get paid, how will they?
- Debt-to-income ratio: If you want to increase the odds of having your loan approved and accomplishing your financial goals, lower your debt-to-income ratio by paying off small loans and credit card debt and closing any unused open credit accounts prior to applying for a mortgage. An excessive number of open accounts reduces your credit rating.
- Property appraisal: Lenders must find out what the house you want to mortgage is currently worth, because the property is used to secure your loan. They do this by getting an appraisal, a written report prepared by an appraiser (the person who evaluates property for lenders) that contains an estimate or opinion of fair market value. The reliability of an appraisal depends on the competence and integrity of the appraiser. Equally important is having an appraiser with significant current market knowledge of the area and type of property being valued.
- Loan-to-value ratio: The more cash you put down, the lower your loan-to-value ratio and, from a lender’s perspective, the lower the odds that you’ll default on your loan. It stands to reason that you’re less likely to default on a mortgage if you have a lot of money invested in your property.
- Cash reserves: As a condition of making your loan, some lenders insist that you have enough cash or other liquid assets, such as bonds, to provide a two- or three-month reserve to cover all your living expenses in the event of an emergency. Other lenders reduce their cash reserve requirements if you have a low debt-to-income ratio or a low LTV ratio. Some credit unions and savings and loan associations require that you have another account (checking or savings) with them to apply for a loan.