Mortgage Underwriting Explained

The mortgage Underwriting process is used by lenders to determine whether the risk of lending to a particular borrower is advisable. Mortgage Underwriters undergo a risk assessment based on a borrower’s credit history and capacity to repay a mortgage. The purpose of underwriting is to determine whether the borrower “can” and “will” repay the loan.  Underwriting has the final decision whether to approve, approve with specific conditions or decline a mortgage loan.

Can the Borrower Repay the Loan?

Lenders will review the borrower’s income, taking into consideration the following:

• Salary and Hourly Wages - Calculated on a gross monthly basis and prior to income tax deductions.
• Retirement and Social Security Income - Must continue for at least three years into the future to be considered. If it is tax free, it can be grossed up to an equivalent gross monthly figure. Multiply the net amount by 1.20%. 
• Commission, Bonus and Overtime Income - Can only be used if received for two previous years. Further, an employer must verify that it is likely to continue. A 24-month average figure is used.
• Alimony and Child Support Income - Must be received for the 12 previous months and continue for the next 36 months. Lenders will require a divorce decree and a court printout to verify on-time payments.
• Self Employment Income - Two years minimum ownership is necessary for a representative sample. Lenders use a 2-year average monthly income figure from the Adjusted Gross Income on the tax returns.  
• Rental Income - The only acceptable source is from an investment property. A lender will use 75% of the monthly rent and subtract ownership expenses. 
• Income on the tax returns.     

Current Debt

Lenders make sure theres enough income for a mortgage payment after installment and revolving debts are paid. The borrower’s liabilities are reviewed for cash flow. Credit cards, leases and loans are factored into the calculation of the borrower’s debt. Loans with less than 10 months of remaining payments will usually not be included in the equation. Expenses like utilities, insurance, food, gas, schooling, clothing, etc. are not considered. A borrower with fewer liabilities will demonstrate to a lender cash management skills.

Debt-To-Income Ratios

There are two debt-to-income ratios which are important for risk assessment by mortgage underwriters . The first is a housing expense-to-income ratio, which is derived by dividing the borrower’s proposed housing expenses by monthly income. The second is a total debt-to-income ratio derived by dividing the borrower’s total monthly debt by monthly income.

The general consensus of lenders is that a house payment should equal 30% of a borrower’s gross monthly income -  And a house payment plus minimum monthly revolving and installment debt should be less than 40% of Gross Monthly Income.

Will the Borrower Repay the Loan?

The underwriting department will review how a borrower manages current and prior debts. Most lenders will pull  a residential merged credit report (RMCR) from the 3 major credit bureaus: Experian, Trans Union and Equifax. The single report includes all three bureaus. The blended credit report includes a public records search for any liens, judgments, bankruptcies and foreclosures against the borrower.  Lenders look at the borrower’s previous credit history as an indicator for future credit management behavior. The underwriter will make a determination whether the applicant is likely to make timely mortgage payments.

Credit Analysis

Underwriters use the following criteria to assess a borrower’s credit risk:

• Unpaid collections, judgments and charge offs must be paid prior to closing an A paper loan (best interest rates). The exception is if the debt was due to the death of a primary wage earner, or if the bill was a medical expense.
• If a borrower has negotiated a payment plan and has made timely payments for 6 to 12 months, a lender may waive an unpaid debt to be paid off prior to closing.
• Foreclosure - 3 years after discharge to be considered for an A paper loan program.
• Chapter 7 Bankruptcy - 4 years after discharge for an A paper loan, if borrower has re-established credit and maintained excellent credit after the bankruptcy. In some cases, 3 years after discharge with a good reason will be acceptable.
• Chapter 13 Bankruptcy - 12 months continuous on-time payments along with a letter from a court trustee can be approved for an A paper loan.

Most lenders agree that a borrower’s current and prior credit history is directly related to whether a loan will go into default.

Compensating Factors

Hard rules won’t apply to every situation because borrowers and their loan files are unique. Underwriters take into consideration a host of variables in their analysis of each applicant. They must put together all the information they’ve gathered into their final decision. Many times, a borrower won’t fit within the parameters of certain lending guidelines. An  example of this might be low income, but the borrower may have other factors like outstanding credit that can offset the risk. Compensations may include job stability, a substantial down payment, or large cash reserves.

For more information on mortgages, visit the experts at New Homes Central Lending.

[tag]Mortgages, Mortgage Underwriting, Home Loans, Buying New Home, New Home Purchase[/tag]

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