About 4 C's of Underwriting
A mortgage lender’s process of assessing the risk of lending money to you is called underwriting.
Before deciding whether to approve your mortgage application and doing underwriting, the bank, credit union, or mortgage lender have to determine whether you are able to pay back the home loan.
So before underwriting, the loan officer or mortgage broker collects the documents necessary for your application.
This is then verified by a mortgage underwriter for your identification, your credit history is checked, and assesses your financial situation in the form of your income, cash reserves, equity investment, financial assets, and other risk factors.
The underwriting guidelines from Fannie Mae and Freddie Mac is closely followed by many lenders which are:
- Maximum loan-to-value (LTV) ratio of 95 %
- 680 or higher credit score
- Debt-to-income (DTI) ratio should be a maximum of 36 %
If an applicant doesn’t meet the requirement in any one area, the loan might still be approved based on the other factors strengths like:
- LTV ratio
- Credit score
- If you will occupy the property
- Amortization schedule
- Type of property and the number of units it has
- DTI ratio
- Financial reserves
It is the mortgage underwriter’s job is to assess delinquency risk, in case you default on paying the mortgage. So, the underwriter evaluates factors that help the lender understand your financial situation, like:
- Your credit score
- Your credit report
- The property you intend to buy
The underwriter documents their assessments and considers various elements of your loan application, on the whole, to decide if the risk level is acceptable.
Let us review the basics of what lenders look for before approving or denying mortgage applications.
The 4 C’s of Underwriting are – Capacity, Credit, Cash, and Collateral. Even if the guidelines and risk tolerances change, the core criteria will not.
The analysis of comparing a borrower’s income to their proposed debt is called capacity.
The borrower’s ability to repay the mortgage is considered here. Lenders look at two ratios.
One is your Housing Ratio. Which merely is the percentage of your proposed total mortgage payment including the principal & interest, real estate taxes, homeowner’s insurance and, if applicable, flood insurance and mortgage insurance – like PMI or the FHA MIP) divided by your monthly income (pre-tax).
A solid Housing Ratio also called the front-end ratio would be 28% or less; while, loans many times are approved at a significantly higher number. Because the front end ratio is looked at in concurrence to the back end ratio.
The back-end ratio also mentioned many a time as your Debt Ratio starts with mortgage payment calculation from the Housing Ratio and adds to it the recurring debts which show up on your credit report because of auto loans, student loans, minimum credit card payments, etc.
without considering other debts like phone bills, utility bills, cable TV, etc. A good debt ratio would be 40% or less. But many loans are granted with higher debt ratios. As every application is different.
Income can be impacted by overtime, night differential, bonuses, job history, unreimbursed expenses, commission, and other factors. Likewise how your debts are considered could vary.
An experienced loan officer can determine how the underwriter will calculate your numbers.
Credit
A borrower’s future payment likelihood is statistically predicted in the Credit check.
The past factors or payment history, total debt compared to total available debt, the types of monies: revolving credit vs. installment debt outstanding) is all reviewed and a credit score is assigned to each borrower to reflect the anticipated repayment.
The higher your score, the less risker you are to the lender usually resulting in better loan terms for the borrower.
Though not impossible scores below 620 are difficult; scores from 620-660 are considered mediocre; good scores are from 660-720, and above 720 are considered excellent.
Your loan officer will look to run your credit so to see what challenges could present themselves.
Cash
After you close, cash is a review of your asset picture. There are actually two components of cash one is cash in the deal and the other is cash in reserves. So the bigger your down payment the stronger would be the loan application.
And the more money you have in reserve after closing the less likely you are to default.
Two borrowers having the same profile with their income ratios and credit scores have different risk levels if one has $50,000 in the bank after closing and the other has $50.
Also, the source of your assets will be examined, whether it is savings or Was it a gift? Is it a one-time settlement/lottery victory/bonus? Preferably discuss how much money you have and its origins with your loan officer.
Collateral
When your home is appraised it is referred to as the collateral. Many factors like sales of comparable homes, location of the home, size of the home, condition of the home, cost to rebuild the home, and also rental income options are considered during the appraisal.
Even though the lender does not want to foreclose, but they need some collateral to secure the loan against, in case of default.
In the current market, situation appraisers are conservative in their evaluations. in most cases, appraisals are the only one of the 4 C’s that can not be determined ahead of time.
Conclusion
Even though each of the 4 c’s is vital but the combination is the key. Strong income ratios and a chunky down payment with strong cash reserves can offset some credit issues.
Likewise, long and strong credit histories can compensate for higher ratios, good credit and income can balance smaller down payments.
The key being you need to talk openly and freely to your loan officer. They would be advocating for you and looking to structure your file as favorably as possible.
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