Underwriting is the process a mortgage lender utilizes to determine the approval or denial of a mortgage loan to borrowers. Underwriters assess the quality of your loan application, specifically the three C's of underwriting: credit, capacity, and collateral.
When evaluating a mortgage loan, the credit aspect refers to how well a borrower or co-borrower manages his or her current and prior debts. Credit reports are pulled from each of the three credit bureaus (Equifax, Transunion and Experian). As part of the full credit reports, credit scores are taken into account as they provide an indicator of how well current and past debt are managed. Data from your credit history produce a credit score (a number between 350 and 850). The higher your credit score the better in terms of default risk.
Capacity refers to your ability to make payments on your mortgage loan. The underwriter will review your employment, income, debts, and other assets for your complete financial picture. As part of the underwriting process, you will be asked to upload paystubs and/or W-2 statements. For self-employed borrowers, lenders will require tax returns such as Schedule C and/or Schedule E filings. The IRS Form 4506-T is typically signed which allows your lender to pull tax returns for past years.
Underwriters evaluate your capacity to pay using an analytical method known as a debt-to-income ratio. This ratio helps dictate how much monthly liabilities borrowers have as comparison to monthly income.
Finally, if a borrower has large deposits or received a large gift of money, an explanation will be required by the underwriter.
Collateral is the third piece that is analyzed by the underwriting process. Collateral refers to the type of property, value, and usage. Property types help determine risk, with single family residences classified as having lower risk and properties such as townhomes, condos, and triplexs associated with higher risk.
Similarly, the type of occupancy is reviewed on the property in question, with owner-occupied having less risk than a second home or investment home.
Finally, the value of the property is also taken into consideration. Value is usually determined by a home appraisal - ultimately producing a value of the property in question supported by recent sales of similar homes with similar characteristics in the same area.
Learn more helpful Mortgage Terms to assist your home buying process.