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A Brief Overview

Understanding Underwriting



Underwriting is the process of evaluating your overall financial picture to determine your ability to repay the loan. Every loan program and lender has their own set of guidelines. Many follow the basic Fannie Mae/Freddie Mac guidelines with their own additional rules applied.

An underwriter is looking at your debt-to-income ratio (income and debts), assets, credit history and property. In general there are some rules that apply but every case is evaluated individually so while the overview below will apply to many borrowers, it certainly won’t apply to all.
Your debt to income ratio is simply a calculation of your monthly debt divided by your gross monthly income. The maximum debt-to-income ratio allowed will vary by loan program but most will fall in the 43-50% range.

Included in your debt payments are your proposed mortgage payment, property tax and insurance (also known as PITI). Additionally, all payments reported on your credit report, such as credit cards, school and auto loans, mortgages and judgements. Other debt will also be included such as losses on investment properties or businesses.

When reviewing you income documents the underwriter is looking for continuity and stability of income.

For a salaried borrower, they will use your gross monthly income. Bonus and commission income can also be included provided if there is a history of receiving it.

For self-employed borrowers, the underwriter will use the income reported on your tax returns after all your expenses and add back any non-cash flow expenses such as depreciation. If your income is declining, the underwriter will call for an explanation to determine what your future income will look like.

Other income can also be included such as investment property income, partnership income, interest or dividend income, royalties, social security, disability income, and alimony.

The key to using any source of income is documenting they exist and will continue.

While most loan programs today will look at your income there are still some programs available that don't require proof of income to qualify. If you are a borrower in need of such a program, give me a call an we can go over options as these programs are frequently changing.
The amount of assets the underwriter will want to see will vary on the type of program. For a refinance, you will need to show the amount of cash needed to close (if any) plus additional funds still in your bank accounts. These funds are called reserves. Each program will have its own reserve requirements, ranging from 0 to 24 months. For a purchase, you will need the down payment, closing costs, and any reserves required. Usually, reserves don’t need to be liquid, so a retirement or investment account will suffice.

When showing assets, it's critical to provide the accounts from which the funds to close are coming. All funds into the transaction must be documented.

If you're using stocks, you'll need to provide proof of liquidation and cash value. If you're using gift funds, depending on the source of the funds, different requirements may apply. Be sure to check with me before transferring any funds between accounts so we can document the source of any deposits properly.
Your credit score will play a large factor in determining your interest rate but your credit history will also determine if you qualify for a loan.

While each loan program varies, most lenders will want to see that you have a minimum number of established trade lines. They will also look at those tradelines to see if you have a history of making on time payments.

Any derogatory accounts will need to be explained, and for major occurrences such as bankruptcies, foreclosures, deeds in lieu and short sales, many programs have mandatory waiting periods until you can apply for a new mortgage. If you have had any major credit problems please give me a call as there are options even if the problems were recent.
Most mortgages will require an appraisal – but not all. An appraisal is an independent third-party valuation of your property based on other comparable sales in your neighborhood.

An appraisal will look at the size, location, age, condition and features (such as pool, garage, energy efficiency, etc) and compare it to similar properties that recently sold in the immediate neighborhood.

Appraisers are primarily concerned with the value compared to the other homes in your neighborhood, but they will check to make sure you utilities are all on, you have a smoke and C02 detector, and your water heater is double strapped. Additionally, they will note if there are any health and safety issues that need to be addressed, such as broken windows, exposed wires etc. If you have concerns about the property, please bring them to my attention prior to the appraisal.

An appraisal is a subjective value so while you may or may not agree with the valuation its used for the purposes of obtaining the loan you applied for only.

The loan-to-value (LTV) is determined by taking your loan amount and dividing by the appraised value. Or, in the case of a purchase, the lower of the appraised value or the purchase price. Typically, the lower your loan to value, the better the interest rate.

While these factors serve as a general overview of how loans are underwritten, they certainly don't apply to all loans. There are many loan programs available from many different lenders, so if you have specific concerns or questions lets talk about them and find a program to fit your needs.