A home may be the largest purchase you'll ever make, so it shouldn't come as a surprise that a financial institution will want to verify that you can afford it -- now and in the future -- through the underwriting process.
What Is Mortgage Underwriting?
Mortgage underwriting assesses the risk of lending money to a potential homebuyer. During this process, you'll submit a loan application, along with documentation to support your earnings, assets and liabilities. You'll also consent to a credit check. The lender will perform an appraisal of the property, which determines whether the offer you've submitted on a home is an appropriate value.
Two important reasons for the mortgage underwriting process are:
-- Risk protection. Financial institutions go through the underwriting process to protect against excess risk and make a wise lending decision, says Mike Oakes, executive vice president of retail operations for U.S. Bank.
-- Responsible banking. The process helps prevent consumers from obtaining loans they don't have the ability to repay, which is in part controlled by federal regulations, Oakes says. "Part of our job is to say we agree they have the ability to repay and that it's a good scenario for both parties," he says.
But mortgage underwriting can take days or drag on for weeks, especially if you're not prepared to submit full documentation, or if your loan needs to go through manual underwriting. If you have your paperwork organized and are ready to work with your lender, the experience can be efficient.
[Read: Best Mortgage Lenders.]
How You Can Prepare for Mortgage Underwriting
Schedule an initial consultation with a mortgage lending officer to determine if you are ready to buy a home, says Ron Haynie, senior vice president of mortgage finance policy for the Independent Community Bankers of America. "There are also HUD-approved housing counselors who can help with special government programs targeted to first-time borrowers or low- to moderate-income borrowers," he says.
A great place to start your preparation for the underwriting process is a toolkit offered by the Consumer Financial Protection Bureau, which will guide you step by step through buying a home, from just considering your options to closing on a home.
The underwriting process will begin once you fill out an application with a lender. You'll be asked for information, including your address, birth date, previous residences, Social Security number and income -- and all of it will have to be backed up by documentation.
Get your paperwork in order before you start the process, as you would for a CPA who is doing your tax returns.
"Consumers should have a good understanding of their financial situation and should be prepared to provide proof of income, employment and assets," which could include bank accounts, investments and real estate assets, Haynie says. "They should also be prepared to disclose their debts, such as credit cards, auto and student loans."
What Mortgage Underwriters Examine
Major factors mortgage underwriters consider are:
-- Credit history and score
-- Property value
Income and assets. If you're employed by a company, underwriters will ask for pay stubs.
Income verification can get complicated, though, if you have inconsistencies due to a bonus or another factor. The underwriter might then reach out to your employer to find out more about bonuses, overtime wages and longer-term equity awards, and possibly to seek additional documentation, Oakes says.
If you're self-employed, more paperwork is likely to be involved, especially around tax returns. This could include personal tax returns and all relevant schedules because the financial institution wants to know more about the long-term viability of your business, Oakes says.
The lender will want to know where your down payment is coming from -- mortgages typically require a down payment, except for special programs that offer low or no down payments -- and will need documentation to verify your funding source. The lender also wants to ensure that you're not borrowing money from somewhere else to make the down payment possible, so you'll need to show how the money got to your account, whether through wages, gifts or other sources.
[Read: Best Mortgage Refinance Lenders.]
Credit history and score. The credit score of the home purchaser is a vital component of the underwriting process. Your score can influence your interest rate and which mortgage programs are available to you.
You can obtain your credit score for free through AnnualCreditReport.com, the only site federally authorized to provide free credit reports, and through some credit card companies. Review the report at least six months before you plan to apply for a mortgage so you can make improvements and correct any errors.
Property value. One of the pivotal parts of the underwriting process is confirming the value of your property. Even though you've agreed to a price with the seller, an appraiser who evaluates the home's condition and the value of similar nearby homes has to back up the price.
Your property's appraisal will then be matched with your mortgage amount. The loan-to-value ratio, which describes the size of your loan compared with the value of the property, also helps evaluate risk. An LTV ratio of 80% -- such as a $160,000 mortgage on a $200,000 property -- is a dividing line; if you borrow more than 80%, you'll typically have to pay mortgage insurance to the lender, says Bill Banfield, executive vice president of capital markets at Quicken Loans.
Other property-related factors influencing underwriting include property taxes, home insurance and homeowners association dues, if applicable, Banfield says. Also, the lender will obtain a review of the title of the home to ensure there are no issues -- such as liens -- associated with it, Oakes says.
Appraisals are subject to appraiser availability and access to the home, however, so this is a potential point for underwriting to stall.
How to Speed Up the Underwriting Process
A prospective homeowner can make the mortgage underwriting process go as quickly as possible by:
-- Ensuring all documents are in order, organized and submitted right away.
-- Knowing his or her credit score and whether it will help secure the desired loan and interest rate.
-- Answering any lender inquiries completely and quickly.
"You can really streamline your own process," Banfield says.
Using digital exchanges is another way to speed up the process dramatically. In Banfield's experience, digital exchanges, such as when the consumer allows the lender to connect directly to another bank to confirm assets, simplify document sharing.
Another way to make the process less taxing is to obtain a verified preapproval letter before you make an offer on a home. Prequalification can give you an idea of how much you might be able to borrow, but preapproval is more concrete. Preapproval means the lender will examine your income, assets and credit to verify your risk factors. It allows you to be a step ahead, Banfield says. If you're preapproved, all you'll need is an approved home offer and an appraisal, he says. You might even be able to lock in an interest rate.
[Read: Best FHA Loans.]
What to Do if You're Rejected in Mortgage Underwriting
If you can't get a lender to approve your loan application, you have options, depending on the reasons for your rejection.
If you're not approved because of a low credit score, take a step back for a few months and work on improving your credit rating. Focus on getting your accounts current and paying down balances.
Or you may need to adjust your offer if the appraiser doesn't agree that the home is worth what you've offered to pay. Go back to the sellers and see if they'll reduce the price to the appraised value so you can get your mortgage approved.
If your income, assets or both aren't enough to afford the home you want, you could choose a more affordable property, save more money for your down payment, or look for assistance through a co-signed loan.
Typically, applications are either approved or denied, but sometimes, mortgages are suspended in underwriting. If that's the case, you may need to provide more documentation to verify employment, income or assets.
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