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What Is Loan Underwriting?

Ben Luthi

Mortgage loan underwriters hold the key to your dreams of becoming a homeowner. The loan underwriting process assesses your creditworthiness and ability to repay a mortgage while ensuring that you and the property meet all the requirements of the loan program.

While mortgage underwriters don't have a lot of wiggle room with approval criteria, the more information you can provide to show you're creditworthy, the better.

What Is Underwriting a Loan?

If you've ever applied for a mortgage or you're planning on buying a home soon, you may wonder: What is loan underwriting?

Underwriting is a process mortgage lenders use to analyze your credit and financial information, as well as the state of the home you're hoping to buy. It's done to determine whether you qualify for the loan you're applying for. More specifically, loan underwriters look at three main factors, often called the three C's: credit, capacity and collateral.

Credit. Your credit history is an important influence on a lender's decision because it shows how you've handled credit in the past. In addition to your credit score, an underwriter will look at your credit report for any negative information.

For example, if you've declared bankruptcy, experienced a foreclosure, or been delinquent on a mortgage or any other type of loan or a credit card, it could be a sign that you're a risky borrower.

Having a good credit history can improve your chances of getting approved and help you qualify for more favorable terms, such as a lower interest rate and down payment requirement.

[Read: Best Mortgage Lenders.]

Capacity. Even if your credit is stellar, an underwriter also wants to know about your ability to make your monthly payments. When it comes to capacity, your income and other debt payments are paramount.

"They're not only looking at where a borrower stands today, but they're looking at what (your) capacity is to service this additional debt," says Joe Thweatt, branch manager and senior loan officer at Axia Home Loans. The underwriter considers what happens after you close and have a mortgage payment to maintain.

A simple way to determine your financial capacity is to calculate your debt-to-income ratio -- that's the sum of your monthly debt payments divided by your gross monthly income. A good rule of thumb is for your monthly housing payment to be no more than 28% of your gross income and your total debt-to-income ratio 36% or less. However, you may be able to get a conventional loan with a debt-to-income ratio of up to 50%.

Underwriters will also consider other factors, such as how many people are on the loan, how much cash you'll have in reserve after you've made the down payment and paid closing costs, and whether your income is based on a salary or self-employment.

Collateral. You aren't the only one who's being evaluated during the loan underwriting process -- lenders also want to make sure the home you're buying meets their standards.

Some loan programs may require that the property meets certain safety and other standards and that the loan amount doesn't exceed the program maximum. Also, lenders want to ensure that the appraised value of the home is enough for the lender to recoup its costs in case you default on your payments.

"Sometimes (the seller) will say cash or conventional loan only," says Scott Hastings, senior mortgage consultant at Angel Oak Home Loans. That might be because the property has issues that would not allow it to pass a Federal Housing Administration or U.S. Department of Agriculture appraisal.

Other factors considered under collateral include your down payment, the type of property and how you're planning to use the home. For example, is it a primary residence, second home or investment property?

Is Underwriting Automated or Manual?

In most cases, mortgage applications go through an automated underwriting system, such as the Fannie Mae Desktop Underwriter. This automated process analyzes the information you shared on your application to determine your eligibility for the loan program.

These automated systems help speed up the underwriting process for lenders, but they don't render a final decision -- that's where loan underwriters come in.

Mortgage loan underwriters provide a human touch to your mortgage application. They'll take the information you shared in your application and the analysis provided by the automated system to determine your eligibility.

There is a true manual underwriting process if the automated system gives a "refer" response, says Hastings. "It just means it has to be fully underwritten manually," he adds, "and those are much more stringent guidelines."

If the underwriter doesn't have all the information they need to make a decision, they may ask you to furnish certain documents. Depending on the underwriter's workload and how much information and documentation you provide upfront, it could take from two days to more than a week to complete the loan underwriting process. Expect longer waits during the late spring and summer, when more people are buying homes.

[Read: Best Mortgage Refinance Lenders.]

Can an Underwriter Deny a Loan?

Mortgage underwriters can make one of four decisions about your loan application: conditional approval, suspend, counteroffer or decline.

Conditional approval. Loan underwriters can't guarantee that your loan will be approved when you close on your home because a lot can happen in the meantime. For example, if you take out another loan, it could affect your debt-to-income ratio. Or if you miss a payment, it could lower your credit score.

"I've had borrowers go out and, even though we advised them not to, bought a nice BMW or purchased another home that they didn't disclose, and we found out about it, and that affected their eligibility," says Thweatt.

Conditional approval means that there are certain conditions you must meet to ensure final approval, and that's generally maintaining the credit, capacity and collateral you had when you were approved.

Those three C's will be reassessed shortly before you close on your new home.

Suspend. In this scenario, the underwriter simply doesn't have enough information to approve your application. You'll typically need to provide more information or documentation to allow the underwriter to make a decision.

To avoid this decision, don't leave anything out of the application and talk to a loan officer before you apply to ensure you have all the documents the underwriter needs.

Counteroffer. If your status isn't enough to qualify for the loan, you could receive a counteroffer, says Thweatt. For example, you may be asked to put more money down or change to a different loan program.

If this happens, read the counteroffer carefully to make sure you don't miss any changes. If you don't like what you see, you can walk away.

Decline. With this decision, the underwriter is stating that you're not eligible for the loan program you applied for or that you don't meet the lender's criteria, which can be more strict than the loan program's.

Depending on your situation, you may still be able to qualify for a different type of mortgage or with a different lender.

[Read: How to Get a Mortgage With No Down Payment. ]

How to Present Your Best Self to an Underwriter

It's unlikely you'll ever speak with a loan underwriter on the phone or face-to-face. But there are some things you can do to make a good impression.

Think of everything. These days, you can apply for a mortgage from your mobile device. But resist the temptation to speed through the process. As you consider your income, be sure to list all of your sources, including child support and alimony, Social Security, or a side business.

Also, take a moment to think of all of your assets and liabilities, even if you have money earmarked for a different financial goal.

Tell the truth. If you're not sure whether your credit or capacity is good enough to qualify for a mortgage, you may be tempted to fudge the numbers to give your chances a bit of a boost.

But it's impossible to alter the information found on your credit reports, and mortgage lenders require documentation for just about anything you claim on an application. If they find you weren't completely honest, it could result in an immediate denial.

If the incorrect information is material enough, such as concealing a second mortgage or inflating the property appraisal, it could be considered mortgage fraud, a crime punishable with a fine or prison sentence.

Address potential concerns before you apply. Buying a home can be an emotional experience, and the excitement of having your own place can make it hard to wait. But if you think you might benefit from improving your credit score, paying off debt or saving up for a bigger down payment, do it.

Even if you think your credit and financial situation is good enough to qualify, you may be able to qualify for a bigger loan or better terms if you take some time to work on your financial position.

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