The ideal loan applicant would make a down payment of 20 percent or more, have six months of saved living expenses, a debt-to-income ratio under 36 percent, a separate savings account for emergencies, a credit score over 740, and a long history of steady employment. These people do exist—but they are few and far between. In reality, one in three Americans has a credit score under 670, one in four home buyers in 2019 were also paying student loans, and average credit card debt was around $6,000 at the beginning of 2019.
Assessing whether borrowers financial blemishes are dealbreakers is the job of the mortgage underwriter. Underwriters are paid to determine whether the risk of offering a loan to borrowers is acceptable, and under what terms. Your financial picture affects both the type of loan you are eligible for and the mortgage interest rate offered to you. Loan officers and mortgage brokers work with the borrower to get mortgage underwriters the information they need to assess the mortgage application.
Home buying is complicated. The paper stack is large, the checklist is long and the regulations are numerous. It easily takes over three months to buy a house, and a lot of that time is spent applying for a mortgage. This is because the mortgage underwriters have a lot of documents to examine including pay stubs, bank statements, W2s, tax forms and other financial documents. How quickly the process moves along is affected by your application (new loan or a refinance), your lender (large bank versus small bank or credit union), the type of loan (conventional or government backed) and your personal financial situation.
In the fourth quarter of 2019, the median home sale price was $324,500. With a 20 percent down payment, that leaves almost $260,000 to finance with a mortgage. In expensive areas, real estate prices are much higher. Lenders want to ensure borrowers have the financial strength to pay back this very large loan.
For salaried borrowers, the paperwork list includes pay stubs, W2s, a list of employers for the past two years, records of any bonuses or commissions and personal address information for the past two years.
For self-employed borrowers, the list is even longer and also includes profit and loss statements, tax returns for the past two years and 1099 forms for the past two years. This longer list reflects the fact that self-employed people can write off a lot of expenses compared to salaried employees, and underwriters want to see income after deductions.
A big part of the mortgage underwriting process involves evaluating the appraisal, as this is the basis for the loan. This part of the process varies greatly depending on whether you are applying for a loan to buy a home or are refinancing an existing home loan.
An appraisal is an unbiased opinion on the value of a home. An appraiser uses similar properties, current market trends, home features and homes conditions to determine the home’s value. Lenders want to make sure homeowners are not borrowing more than a home is worth because the home is the collateral for the mortgage. If the borrower defaults, the bank wants to be sure it could sell the property and recoup most of its money.
When the appraisal value is lower than the agreed purchase price, the transaction can be delayed or canceled. This generally does not happen with new home purchases, as both the buyer and seller are motivated to close the deal.
Refinancing is trickier. Homeowners often believe their house is worth more than it is. They look at what a neighbor’s house sold for and what Zillow and Redfin list their home value as, and seek an appraisal for that higher value. If the house is not worth the $50,000 more it is appraised at, it might not be worth refinancing, as you then have less equity than you anticipated and the interest rate will not be as favorable. “Zillow and Redfin are a great indicator, but not a bible for what you should be using,” explains Melissa Adamo, a senior mortgage advisor with Own Up. “They can inflated or deflated. It’s just a guide.” She says underwriters look for conservative appraisal values that are in line with the market.
People applying for government backed loans (FHA, VA, USDA) will also find the process more rigorous, as the government is taking on the risk and wants to insure the home is worth the selling price.
The Financial Assessment
Mortgage underwriters look at three main areas to assess a borrower’s ability to pay. They are credit, capacity and collateral. The initial assessment uses automated underwriting systems to assess basic information in each category using the document submitted by the borrower. For credit, the system looks at your credit score, any foreclosures or bankruptcies, the status of any revolving loans and other aspects of your credit history. For capacity, the system looks at your debt-to-income ratio (DTI), your cash reserves, your employment situation past and present, and the loan characteristics. For collateral, the system looks at your down payment, and the property type and use. People with conventional loans and less than a 20 percent down payment, must pay private mortgage insurance (PMI), a cost that must be factored into the ability to repay the loan.
Often, this process will raise red flags. Manual mortgage underwriters take over from the computers and look at individual issues to see if they need more information. How this information is assessed depends on both the type of loan you are requesting and the lender you are using. This entire process takes two to three weeks.
Government loans (VA, FHA and USDA) require more paperwork and more scrutiny. These loans allow for lower down payments and lower credit scores, so borrowers are more likely to have blemished records that could include missed mortgage payments or short sales, and underwriters have to carefully assess the risks of making these loans. These loans also come with more rules. While homebuyers sometimes choose to buy fixer uppers to save money, this is not an options for government-backed loans as they require houses to be in better shape. Other parts of the process provide latitude, including the VAs policy of appraisals lasting six months (conventional loans require a new appraisal when you switch lenders), Adamo says.
The lender you choose could also influence this part of the process. Large banks are likely to sell their mortgages to Fannie Mae and Freddie Mac. Because of this, they must meet certain requirements, while local banks and credit unions that are holding the loan may be more lenient (though this is not certain).
There are many reasons mortgage underwriters will have questions about your loan application, and they usually not reasons to worry. If a mortgage underwriter has a question they can’t answer, they will ask for a Letter of Explanation, and they do so frequently. According to the community forum on MyFICO.com, the most common reasons for a Letter of Explanation relate to credit, income and later payments. USDA and VA loans also make the top 10.
There are many understandable life situations that might raise red flags to an underwriter, but can be explained. These include a period of late payments on your credit report that could be due to an illness or injury, a high level of debt because you live in a very expensive area and don’t make a lot or self employment income that changes from month to month.
Other people have turned their financial picture around but have a foreclosure or bankruptcy in their past. These people will be asked to explain how they have righted their financial ship.
There are also items that raise questions and just require an explanation. These include names not matching because of a marriage or divorce, or one-time large deposit that was a gift from a family member.
Adamo says underwriters are not as stringent as some people fear. While two years of income is preferred, she says they will consider less if someone recently graduated college and has a good job. Student loans are also not as much of an issue as some people fear. Underwriters only care about the monthly payment—not if the loan is $50,000 or $150,000 total.
Ten days before closing on a loan, loan officers ask for verification of employment. If you switch jobs during the underwriting process, only do so if you have a contract or offer showing what you will make. Switching from a salaried to 1099 position is not advisable during this period, Adamo says.
Loan applications are sometimes rejected, but it is infrequent at Own Up. This is because we will not send a borrower’s application to a lender if we do not believe it will be approved. There are also situations where applications are denied. This includes if someone lied about something on the application or if borrowers are fired or laid off during the loan application process.
The homeownership journey is a long one, and this last step, mortgage underwriting, can be the most stressful of all. Own Up understands this and works with buyers to educate them throughout the process, find them a better mortgage interest rate and answer any questions. We take advantage of technology to be able to negotiate lower fees with lenders and pass the savings onto you. If you are looking to buy a house or refinance an existing one, give us a call. We look forward to hearing from you.