Underwriting a Loan
This article authored by: Catherine Hallberg
Towards the end of loan processing during a home purchase you will be informed that your loan has gone into underwriting. What does that mean?
Mortgage underwriting is the process a lender uses to determine if the risk of offering a mortgage loan to a particular borrower under certain parameters is acceptable. Banks and lenders create guidelines that analyze the various aspects of the mortgage and provide recommendations regarding the risks involved. However, it is always up to the underwriter to make the final decision on whether to approve or decline a loan.
One of their considerations is your credit score as this provides an indication of how well you manage debt. The higher the score, the less risk to the lender. The history of payment of loans and revolving credit is considered as well. Repossession, judgements, foreclosures, bankruptcies and liens are scrutinized and lenders may require you pay off some current debts before they will grant a mortgage.
Another area of review is the borrower’s employment, other forms of income and assets. Someone who’s employed by a company and receives a paycheck is a lower risk than a person who is self-employed or works off of commission. Stability of income is what they are looking for. Surprising to many is that you may have a sizeable bank account but be denied a loan as you don’t have a current verifiable source of income.
The type of property and its intended use is also considered. Homes used as primary residences or second homes are less risky than property used for rental purposes. The type of property factors into the equation as well. Single family homes are considered to be more stable than condominiums.
Underwriters consider the value of a home when deciding on the amount of loan they are willing to grant. Price, cost and value can be different. Price is the amount the Seller and Buyer have agreed to in the purchase contract. Cost is the amount needed to build the same type of home including labor and materials. Value, which is usually the most important characteristic, is the dollar amount that is supported by recent sales of properties that have similar characteristics, in the same neighborhood. An appraisal is generally required to establish value. This is critical to loan approval as if the home needs to be foreclosed upon, the lender must be able to sell the property to recoup their losses. The appraisal helps to establish loan-to-value (LTV). Homes with a higher ratio of LTV are riskier than those with low LTV. As a result, a lender may require a higher down payment to reduce a high LTV or the Seller may have to lower the purchase price.
After reviewing all aspects of the loan, the underwriter assesses the risk of the loan as a whole. No two buyers are alike. There is a concept known as layering of risk. For an example, if the property is a high rise condo, occupied as an investment, with a high LTV and a borrower who is self-employed, the cumulative effect of all these aspects yields higher risk. Though the borrower may meet all requirements under the guidelines of the loan program, the loan may be denied as too risky.
A great lender will be familiar with their underwriter’s guidelines when first pre-approving a loan. The more information you can provide on the initial meeting, the better your chances of having your loan approved without additional conditions.
A home mortgage is a big investment for both the borrower and the lender, so be sure and meet with a lender to establish how much you can qualify for before looking at homes. That way you won’t be disappointed when you find your dream home and can’t afford to buy it.
Rob and Catherine Hallberg are Associate Brokers with Long Realty, a Berkshire-Hathaway Affiliate and Southern Arizona’s largest Brokerage. Since 2008, they have been ranked in the top 5% to 8% of all U.S. REALTORS®. Send Rob and Catherine an email for a fast response to your questions; for an even faster response, Call (520) 407-8667