Everything you need to know about underwriting
You’ve found the house you want to buy. You’ve secured the money. You’ve even selected a lender to work with and guide you through the entire mortgage process.
Now, what’s this about underwriting?
While many prospective homeowners have likely heard the term before and may even have a basic understanding with what an underwriter does, there are others who know very little about the role and purpose of underwriting. After all, it’s not an everyday term.
In this article we’ll take you through what to expect from a mortgage underwriter, how the underwriting process works and what you can do to optimize your chances for a clean, issue-free approval when applying for a mortgage on your new home or doing a refinance.
What is underwriting?
In the world of banking and mortgage, loans aren’t issued based on the cut of your jib, who you know or where you work. Lenders require an extensive process to evaluate your finances and financial behavior to ensure that you're a good candidate to repay the loan on time. Lenders don’t like to take unnecessary risks.
Underwriters assess the risk of lending money to you on behalf of the lender.
An underwriter will examine your credit, income, debts and asset documentation and make a determination to approve or deny the loan based on your overall financial position in context of the size of the loan you are seeking. The decision they render depends on the above factors as well as your credit score. We’ll talk more about these in a moment.
In addition, the mortgage process today has become more digital and streamlined, and many lenders now possess advanced underwriting technology that allows them to perform preapprovals in minutes, while also reducing turn times for the final underwriting process.
The mortgage underwriter
While underwriters also exist in both the insurance and securities industries to assess relevant risks therein, this article is only concerned with mortgage underwriters and how their analyses affect your chances for loan approval. Additionally, underwriting is typically broken down at a lender into three specialty groups:
- Conventional: Fannie Mae and Freddie Mac conforming loans
- Government: FHA, VA and USDA loans
- Jumbo: Loans beyond the limit set by Fannie or Freddie and therefore not backed by any GSE or federal program
Applying for a loan is a document-intensive process where loan officers and their associates (for example, mortgage consultants and loan coordinators) are tasked with collecting a wide array of financial data to ensure they have a complete and accurate financial portrait of the borrower in order to properly assess risk.
Due to the complexity and number of tasks involved and the importance of rendering a fair decision based on all the facts, manual underwriting can take some time—anywhere from a few days to a few weeks depending on the borrower’s ability to obtain an appraisal and furnish all applicable documentation in a timely manner.
What does an underwriter do?
Historically, underwriters have performed many of the following steps as part of their approval process:
- Verify income & employment
- Examine borrower credit history and credit score
- Analyze debt-to-income ratio (DTI)
- Ensure ample savings and other assets exist
- Have an appraisal of the home and property done
- Render a decision on whether to approve or deny the loan
Verify income & employment
Many steps in the underwriting process are based on inspecting financial-related documents to ensure that the applicant has sufficient funds to secure the loan and make monthly payments without defaulting. Verifying income is one of these steps in this assessment.
Typically, underwriters will want to see W-2s from the last two years as well as your two most recent paychecks in order to confirm the consistent receipt of income. For self-employment, a more extensive set of documents are required including profit and loss statements, balance sheets, K-1s and recent personal and business tax returns.
Examine borrower credit history and credit score
Once they enter into the homebuying process, borrowers are quickly accustomed to their credit score—that three-digit number that encapsulates their creditworthiness—being used everywhere as a measurement of financial health. Underwriters will pay close attention to your score but they will also examine your credit history in the form of a detailed credit report to determine if there are any red flags such as late payments, bankruptcies, foreclosures or overuse of credit.
Analyze debt-to-income ratio (DTI)
To determine DTI, underwriters will need to be provided with a list of both your monthly income and monthly debts. The lower your DTI, the better it is for your approval prospects. Most large lenders prefer to see a DTI of 43% or less for a conventional loan.
An individual with a $6,500 monthly income and $2,200 in consistent monthly expenses (proposed mortgage payment [$1,600] + other household expenses [$400] + student loan [$200]) will have a DTI of 34%. This is calculated by dividing total monthly expenses by total monthly income.
Ensure ample savings and other assets exist
In determining whether or not you’re a suitable candidate for a new loan, the underwriter will need to take a look at your savings as well as any liquid assets that are available to cover downpayment and closing costs.
Pertinent assets are anything that can be turned into liquid cash--real estate holdings, stocks, bonds and other securities and even things like cars, boats and works of art.
Savings are important because they are the borrower’s safety net should they face unexpected financial hardship at some point during the life of the loan. This asset type is known as reserves Both savings and checking accounts will count toward reserve requirements.
Have an appraisal of the home and property done
A lender never wants to approve a loan amount that is in excess of the value of the home being purchased; this is the chief reason that an underwriter will order an appraisal to be conducted. The lender wants to be absolutely certain that the loan being offered is commensurate to the value of the home.
Render a decision on whether to approve or deny the loan
It all boils down to this: Can you afford the costs of the home given your income and assets? Does your financial history indicate that you are a low-risk candidate for the lender to extend funds to?
A good underwriter works diligently to compile a complete portrait of your financial history, including all streams of income, assets, debts and credit behavior over an extended period of time. It’s an evaluation that demands patience, knowledge, thoroughness and full access to all relevant documents.
The underwriting decision: common outcomes
At the end of the process, the underwriter must make a decision on the loan for which you’ve applied. In the best of all possible worlds, that decision is an approval that enables you to proceed to closing.
The least favorable outcome, of course, is denial. This means the lender will not approve the loan you've applied for. This can be crushing news to prospective homebuyers.
Another common judgement is for the underwriter to say “approved with conditions.” This is a type of loan status that is almost always a precursor to final approval by the underwriter. It typically comes after initial review where it’s understood approval will be granted pending the furnishing of additional borrower documentation, appraisal, title insurance, etc. Once these administrative issues are resolved (and subsequently reviewed by the underwriter), borrowers will receive the “clear to close” signal and move to the final process in procuring a mortgage.
Technology and underwriting
We can’t possibly describe the role of the modern underwriter without also talking about technological advances that have enabled many underwriting processes to go digital, or be entirely automated.
While the role of AI and machine learning within underwriting is not widely appreciated by most prospective homeowners and those seeking to refinance, it is a substantial component to the modern underwriting process. Automating certain underwriting tasks can reduce turn times from hours or even days to mere minutes. And digital advancement is not only rendering unprecedented efficiencies, but also enables underwriting to reduce errors and even track behavioral patterns that help determine creditworthiness of borrowers.
Preapprovals, prequalifications and underwriting
Preapprovals are becoming almost indispensable within the retail mortgage sector, as more and more lenders are leveraging the many inherent efficiencies of digital technology (in concert with seasoned professionals) to rapidly determine basic loan eligibility and approval. These automated underwriter systems (AUS), employ rapid, automated processes that use advanced algorithms as part of a sophisticated software system to make preliminary underwriting decisions. Hence, the preapproval.
Borrowers like preapprovals because they provide validation of their financial power and perceived creditworthiness by the lender. Sellers like them because they provide the necessary proof that the borrower has the financial might to make the purchase, allowing them to compete with cash buyers. Without a preapproval, many borrowers experience unforeseen last-minute obstacles when trying to get approved for their mortgage.
Lenders like preapprovals for the same reasons, as well as the added bonus of having an opportunity to establish a methodical step-by-step process for reviewing and verifying the many files that accompany the underwriting process without the last-minute crunch. Ultimately, this makes it easier to spot issues and submit conditions ahead of time, issues that could otherwise cause delays during the final phase of underwriting.
Prequalifications are different from preapprovals and are not typically verified by a lending institution. They merely give you an indication of affordability—not a thorough vetting thereof.
What you can do to optimize the underwriting process
While much of your credit history and financial behavior will have been set in advance of your home search and mortgage application, there are a few things you can do as the process kicks off to optimize your chances of a clean underwriting experience.
Avoid any significant life changes including new lines of credit
You don’t want to create any surprises for the underwriters assessing your creditworthiness as your big day approaches. With this in mind, it’s unwise to make any large purchases or open any new lines of credit that may impact your credit score and jeopardize your application.
You’ve likely been preapproved already by the lender; now as closing moves into sight, they’ll review your employment, assets, debts, credit history and credit score one more time. You don’t want to derail an approval by making any material changes that will force the underwriter to issue new conditions, etc.
Be accessible to the underwriter and respond in a timely manner
It’s important to remain accessible during the underwriting process. There are times when the underwriter or other loan professionals have questions, require clarifications or need additional documentation to finish their job. For example, joint bank accounts or income from alimony or child support payments may necessitate additional, verifiable documentation. Make sure to respond to any queries immediately so your application remains at the top of the underwriting queue.
Always prioritize honesty in your interactions with underwriting
Communicating effectively, timely and honestly with your lender is of critical importance throughout the mortgage process. Regular, transparent communication with the underwriter is always going to put you in a better position than “going dark” or providing ambiguous or errant documentation in an attempt to fudge the facts.
Sometimes it’s as simple as taking a moment to explain a period of unemployment or providing a legitimate reason why a single credit card payment was missed. Only by accurately explaining your perspective in full detail can the lender make an informed decision based on the facts. Issues are part and parcel of the underwriting process; how you deal with them can make a huge difference as to when and if you are approved.
Given the inherent complexity of the homebuying process, prospective homeowners and those looking to refinance need to do all they can to avoid unexpected issues that may contribute to potential delays. Delays are almost never advantageous to the borrower; they invite seller anxieties and may put your loan approval at risk. This is precisely why you always want to do everything you can in advance to ensure a smooth underwriting process with as few conditions as possible.
Remember, the underwriter is there to measure the risk to the lender and to make sure you— the borrower—have been fully vetted, and if approved, will be a strong candidate to pay back the loan as agreed. Underwriters perform a vital behind-the-scenes function for lenders and are a critical component to any mortgage process. Make sure you assist them by providing all the necessary financial documentation in a helpful, timely manner.