Underwriting is the process that the lending institution uses to determine the credit worthiness of a borrower to be given a home loan. Underwriting is the process of reviewing the borrower’s credit profile as well as the property he or she intends to purchase to determine the likelihood of repaying the loan as agreed. Here is a more in-depth look at the underwriting process and what lenders evaluate:Here is a more in-depth look at the underwriting process and what lenders evaluate:
An underwriter is the one who performs the underwriting process. They perform for the mortgage lender and investigate each borrower together with the real estate property to determine loan risk. Some key responsibilities include:
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Scoring the credit report of the borrower and his or her score in order to determine their credit worthiness and history of repaying loans.
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This process involves confirmation of income and other financial details of the borrower such as assets and debts using documents such as pay slips, bank statements, and tax returns.
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A borrower must have enough cash to make a down payment and to pay other costs associated with closing.
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Getting the property appraised to know its value and ensuring that it is sufficient security for the amount borrowed.
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Determining the debt to income ratios according to the borrower’s income and expenditure.
- Assessing other factors of additional risk such as the kind of loan, the amount of money required, property occupancy, and market situations
Depending on the identified risk level, the underwriter determines whether the borrower and the property meet the requirements for the mortgage loan amount and the specified conditions. If the risk is too high they would ask for some additional documents from the applicant or may suggest to change the amount of the loan and the conditions to approve the application.
What information do underwriters seek?
When underwriting home loans, lenders evaluate three key criteria: collateral, capacity and credit.
Collateral
Collateral simply means the property that is attached to the loan. Underwriters run various assessments to confirm the property is adequate loan collateral, including:Underwriters run various assessments to confirm the property is adequate loan collateral, including:
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Appraisal – Gives an opinion of market value given by an appraiser with a license to do so. Checks that the market value is adequate for the amount borrowed.
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Surveys – To assess the structural or maintenance defects that may affect the value of the property.
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Equity and down payment amount – It is the comparison of the amount borrowed to the value with a view of minimizing risk. Usually entail down payments of 10-20% on traditional mortgages.
Capacity
Capacity focuses on the borrower’s capacity to make the payments now and in the future to pay the mortgage. To evaluate capacity, underwriters confirm:To evaluate capacity, underwriters confirm:
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Employment status and history – job hopping or constantly changing jobs will lead to a negative implication of credit worthiness.
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Employment status and income – Scrutinizes pay slips, W-2 forms, and tax returns for secure and steady income streams.
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Debt-to-income (DTI) ratio – This compares the total monthly obligation to gross monthly income. Conventional loans allow maximum DTIs of up to 43% for most mortgages.
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Down payment and closing costs – Confirms financial savings and other assets to meet emergency besides the down payment and closing costs.
Credit
A borrower’s credit report and scores give information on how he/she has been repaying their current and past debts. Key aspects evaluated include:
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Payment history – timely payments are good whereas delayed payments need further consideration.
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Different kinds and the number of credit accounts – Different kinds of credits (mortgage, auto, cards, etc. ) prove the applicant’s ability to handle various types of debts. New accounts can be too high and this may be an indication of risk.
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Inquiries – Many recent inquiries can indicate that a borrower is actively seeking and opening a lot of new accounts.
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Length of credit history – Generally, longer credit history indicates lower risk compared to short or no credit history.
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Negative remarks – Any payments which are made a few weeks or months ago, collection accounts, bankruptcy, and foreclosures must be justified.
- Credit ratings – Minimum credit ratings of between 620 and 700 considered acceptable depending on the type of loan. This is because, the higher the score, the lower the risk.
Loan conditions and stipulations refers to:
If an underwriter observes an area of concern regarding collateral, capacity, or credit that does not lead to the borrower’s elimination, then they may ask for further proof or make loan approval conditional. Common conditions imposed include:
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Less exposure to risk by making higher down payments or taking lower loan amount.
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A necessity to make repayments to outstanding obligations to reduce DTIs
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Gainful account for derogatory credit remarks
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Home repairs carried out before funding
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Required to pay for private mortgage insurance if one obtains a loan with high loan to value ratio
- Higher interest rates to communicate any risk noted
Underwriters may also recommend or demand changes in the loan type or the period. For example, it can offer a choice of an ARM, FHA, or other non-conventional program suitable for applicants with a less-than-stellar credit score and other discrepancies.
The Bottom Line
Underwriting assists lenders to manage risk when providing funds to enable the purchase of homes by borrowers. When underwriters know how risky a loan is by analyzing collateral, capacity, credit, and in general the overall risk of the loan, they can then decide who qualifies for a loan and the terms that will enable the institution to be compensated in proportion to the risk it is taking. On the other hand, underwriting acts as a shield for lenders while also guaranteeing that borrowers only access the credit they are in a position to repay. This helps to avoid future problems of financial unrest for all the stakeholders. Knowing how underwriting works is crucial so that homebuyers can have a better chance of having their application approved.
