Understanding Mortgage Underwriting And Processing

mortgage-termsWhat you as the applicant should understand about mortgage underwriting and processing.

Processing a loan and underwriting a loan is not a magic process. It is a well thought out structure to know that the loan being documented and reviewed meet all mortgage loan requirements. It includes but not limited to:   1) Does the borrower have the capacity to repay the mortgage loan? 2) What, if any are the risk factors? 3) What is the payment shock?  4) Does the borrower’s credit score meet all guidelines? 5) Does the borrower have stable income that will continue for the near future? 6) What equity will the borrower have when the loan is closed? 7) Does the borrower have sufficient funds to close and are those assets from their savings, gift, down-payment assistance, and is the first payment available? 8) Does the property appraisal support the sales price, and property value based upon the immediate area and investor guideline.

Let me remind you, yet again, though it seems excessive, it is necessary to fully implement due diligence and determine whether someone really does qualify for a loan.

General Underwriting Rules

It was previously stated that the agencies (FNMA & FHLMC), underwriting and processing guidelines are going backward to some degree, toward the manual underwriting process.  Now it is leveling out to some degree, however, guidelines must ensure that an applicant can carry the increased debt they are about to embark upon.  Fannie, Freddie, and FHA  has emphasized that it is the lenders responsibility to verify anything that is questionable with regard to the mortgage applicant’s application.  Anything that might prevent the performance of a loan must be questioned and documented. They are being upfront with the fact that there are instances when there must be additional information verified to make certain loan applicants have the willingness, capability and capacity to pay back the mortgage loan.

The agencies both have automated underwriting systems and these systems are initially run by the processor to see what the minimum documentation is and then anything questionable must be documented also.  The underwriter then uses their expertise to further analyze the file, the documentation and the overall risk factor that may exist.  The automated underwriting systems spit out minimum documentation requirements from what has been entered into the system. It is a machine so it cannot see with the human eye and only uses information it has been given by the human; therefore, there is room for error. When something changes after it is documented; (income, assets, liabilities, after being verified) the automated underwriting system must be changed along with the new information and new underwriting requirements review yet again. 

These systems are governed by humans and as we all know humans make mistakes and even though there are explicit guidelines that should be followed; there are still errors made that can change the approved status to a declined status.

These are some facts about processing and underwriting a loan that any Mortgage Underwriter or Processor must consider:

  • Large deposits on bank statements and small deposits on a regular basis which are not income related.
  • Reserves and the ability to accumulate savings is evaluated, does the borrower have sufficient income and assets to afford the payment that might be increasing from the rent he/she now pays or mortgage payment?
  • Bank statements are evaluated for balance versus previous balance with savings ability and liquid funds after closing plays a role as a risk factor and these accounts; 401K accounts, CDs, Stock, Mutual funds, IRAs, Money Market etc. are evaluated.  Usually someone who has a proven ability to accumulate savings will demonstrate less risk and has the ability to continue the payments as agreed or pay off the debt should there be a loss of job, illness or extenuating circumstances.
  • Money for down payment and closing cost must be the borrowers own funds unless the product allows for gifts such as FNMA Flex 97 or Community Home Buyer and for FHA.  Most products call for a 5% down payment from own funds (conventional), however, there is a 3% down-payment product.
  • Deductions on pay stubs and if a person who just gotten a recent raise and the income must be calculated in a consistent way.
  • Verification of employment (if applicable) forms completed by someone other than the human resources department is evaluated, and a verification of employment that is not consistent with pay stub or year to date lower earnings versus the hourly rate or salary (it can mean a borrower has been off work for some reason). Earnings that increased drastically from previous years which have not been explained as a salary increase or if in self employed gross sales increased.  The latter will be present in the schedule C. Bonus income must be analyzed and must be averaged over the past 24 months as a general rule but, *sometimes last 12 mos history is used
  • Commission income must be an average of the past 24 months but *sometimes last 12 mos.
  • Tip income must be averaged over the past 12 to 24 months and should be consistent with the job.
  • Any discrepancies in a pay stub from W-2 earnings must be analyzed.
  • Child support payments as income must be documented for consistency and length of time and alimony payments
  • Credit reports must be analyzed for the frequency of late or delinquent accounts, the number, how recent, excessive or infrequent, what type of accounts. Excessive inquiries on the credit report must be analyzed for the past 6 months for new loans if current that might not showing on the credit report and previous for excessive credit searches. A person who has multi- revolving charges with their current balance as high or near the high balance or maximum balance is considered as not conservative spender and a higher risk. Any history of public records such as, bankruptcy, foreclosures, collections, judgments, tax liens, or deed in lieu is considered a higher risk and extra precautions, rule, guidelines and evaluation with documentation must be performed
  • A person without credit must be evaluated for non-traditional credit such as phone bills, car insurance, utilities and any debt that can be verified for the past 12 to 24 months
  • Research has shown that a person who has never had a mortgage loan presents a higher credit risk per the agencies than some who has a proven track record of paying a mortgage payment
  • Rental history must be verified and have no late rental payments; these are analyzed just like a mortgage history
  • When (1040) tax returns are required; the income is average over that past 24 months as a general rule, all schedules must be present.  If a person who is self-employed writes everything off (expenses) and there is little or no income to be utilized it is not within the Mortgage Underwriters ability to use anything but the bottom line real income.  The net income plus depreciation may be added back and then is averaged over the 24 months.
  • A sole proprietor is responsible for the entire debts/liabilities of the company.
  • Self- employment less than 12 months is usually not allowed.
  • Self- employment income must be analyzed for consistency over a period of time, the income and the company must be evaluated for indication that it is a reliable business that will be in operation for the foreseeable future.
  • An applicant who works 2 jobs, must have a history of working 2 jobs, usually at least 12 months and the income must be consistent and likely it will continue.
  • Applicant’s debt to income ratio is analyzed to make sure that the new mortgage payment does not overload the borrower’s ability to pay their obligations in a timely manner, usually anywhere from 36 to 45% as long as there are sufficient reserves and assets to allow for the higher 45%.
  • The loan type plays a role in the risk factors of a loan approval.
  • Down payment amount (equity after the loan closes) plays a role in risk factors.  A 20% down payment highlights strength.

The above is not conclusive still, however,  it represents why so much is at stack in the evaluation of a mortgage loan and the analysis which must occur before an approval is rendered.  There are and has always been many aspects to the approval of a mortgage loan.  It is a very detailed process and many concerns sometimes arrives after the application is submitted and must be address.  It is imperative that any applicant should tell the mortgage processor everything that is relevant in their financial or credit history, upfront.

Some call for more common sense underwriting, but common sense means that you make sure what you see in front of you is the real deal and not something concocted up for the loan that is being pursued.  This is of great importance to the mortgage underwriter and processor and everyone should respect their role in complying with quality standards and regulations.