Mortgage Underwriting: Everything You Need To Know
The good news? You’ve found your next home! That’s great!
The bad news? There’s an approval process that stands between you wanting the property and you being able to pay for it.
For many people, applying for a mortgage is a stressful and somewhat mysterious process. As the mortgage application process becomes more and more automated, it can be difficult to ask questions along the way.
Don’t worry, though. We’re here to help by demystifying the mortgage approval, or underwriting, process.
What Is Underwriting?
Mortgage underwriting is the process of verifying and analyzing the financial information you provide to your lender. That information concerns your income and assets, your credit history and the property you wish to buy. Underwriters look at a variety of factors to evaluate whether you will be able to make your payments and also to determine if your home will be worth enough to cover your mortgage loan should you default.
What Does An Underwriter Do?
If you’re getting a mortgage, it’s the job of the underwriters to make sure that all the information you have provided is true and accurate. To do this, the underwriter assigned to your application will:
- Review your credit score and order a credit report. Keep in mind that the type of loan you are applying for determines the median FICO® credit score required.
- Order an appraisal of the property you wish to buy to make sure that the amount being financed is not more than the home’s value
- Verify income and employment
- Evaluate the amount of debt you are carrying (more on that below)
What Is The Underwriting Process?
So, what are underwriters looking for? They need to analyze your IPAC – income, property, assets and credit – the four key pillars of any mortgage approval.
Let’s go through each of these so you understand what happens during underwriting and the materials you’ll need to provide during the process.
The first thing underwriters need to know is how much income you have and how regularly it’s coming in. This is a huge factor in your ability to pay your mortgage.
There are three types of documents a lender will typically ask for to verify your income:
- Your W-2s from the last 2 years
- Your two most recent pay stubs
- Your two most recent bank statements
If you’re self-employed or have more than 25% ownership in a business venture, your lender will require different documentation. The requirements may vary depending on the type of loan you’re applying for, but these are some of the documents commonly requested:
- Balance sheets
- Profit and loss statements
- All pages and schedules of business and personal tax returns
At this point in the process, underwriters will also verify your employment.
While the underwriting process is happening, your lender will order an appraisal of the home you wish to purchase. This is often required when refinancing if the value can’t be verified another way and is always required for home purchases.
The purpose of the appraisal is twofold: It protects you from overpaying when you’re buying a house, and it protects the lender and investor (Fannie Mae, Freddie Mac, FHA, etc.) from lending more than the value of the house.
Because the house serves as collateral for the loan, it’s necessary that the investor be able to recover invested capital if the borrower defaults on the loan. In other words, the lender wants to be sure that if you default, it can sell the house to recover what you owe on the mortgage loan. Because of this, lenders won’t let you borrow more money than the house is worth.
Underwriters will also look at documentation verifying any saved assets you may have such as checking and savings accounts, stocks, bonds and proceeds from the sale of tangible items. When an underwriter reviews your assets, they look to make sure the money is actually yours, and not just a loan from someone else.
Your underwriter may also check to make sure you have cash available for reserves. Reserves are measured in terms of the number of months you could make your mortgage payment if you lost your income.
Some loan programs require reserves. Even if they aren’t mandatory, having reserves makes you more likely to be approved because it demonstrates that you’re prepared for the financial responsibility of homeownership.
Underwriters take a close look at your credit history. Remember when you were in school and teachers threatened to document your misbehavior on your permanent record? Turns out, as an adult, your credit history is the closest thing to a permanent record that life has to offer.
Underwriters want to know, of course, whether you have paid and continue to pay your bills on time. But they also need to be able to review any documents detailing how much other debt you owe, in the form of car payments, student loans, or credit card debt or other liabilities. Even if you’ve been keeping up with all your payments, too much debt relative to your income – often referred to as your debt-to-income ratio (DTI) – is a strong indicator of future financial difficulty.
After the subprime mortgage meltdown contributed to the 2008 financial crisis, lawmakers empowered the Consumer Financial Protection Bureau to create new consumer protection requirements to make sure that borrowers could repay the loans they were issued. DTI became a major determinant of whether a consumer was financially fit enough to take on mortgage debt. These regulations are consistently reevaluated, but for now, DTI is still a heavily important factor in how much you can afford.
Additional Documentation Needed
Aside from documents associated with IPAC, your underwriter may also require you to provide other pieces of information to gain a more comprehensive understanding of your financial history. For instance, legal documents that verify court-ordered debt – like alimony or child support – might be necessary to complete the underwriting process for your mortgage loan. Be sure to have any divorce decrees, court orders or letters from friends of the court that may have an effect on your overall financial situation on hand as you begin to work with your underwriter.
If you’ve previously rented property, some mortgage programs require records of your rent payment history for at least 12 months to be provided during your underwriting process. Regardless of the type of mortgage loan you’re pursuing, make sure you check on the specific documentation requirements set by your lender and underwriter so you can avoid having to scramble at the last minute to compile the necessary materials to get a mortgage approval.
What Do Underwriters Do With My Financial Information?
Once they’ve gathered all the information that they need and have verified its accuracy, underwriters begin their analysis. At its core, underwriting is about identifying risk. Underwriters use your past financial behavior, mountains of data from past transactions, and mathematical models to make predictions about your future financial behavior.
Once they’ve determined how much of a risk an applicant presents, lenders can figure out how much they’ll need to charge in interest to make that risk worthwhile to them. Keep in mind that there are two aspects to risk: the general risk associated with economic factors and the cost of money, and the likelihood that you, as an individual, are likely to repay debt. When you see posted mortgage rates, they are typically the lowest possible rate available to borrowers with excellent credit.
If you have an excellent credit score and history, your mortgage’s interest rate will be close to those posted rates. Your history and low debt load present a low risk of future default. If you’ve had financial difficulties in the past or are carrying a large amount of debt, your interest rate will be higher. Lenders need to make more money on your mortgage to incentivize them to take on the greater risk that you will default.
How Long Does Underwriting Take?
If all of your paperwork is finished and all of the proper documentation is provided, the underwriter could finish their work within a couple days. However, if the information you’ve shared with them is incomplete in some capacity, it could take up to a few weeks to get past the underwriting stage of your mortgage approval; you’ll need to fill any informational gaps and provide your underwriter with any additional materials they’ll need to verify all aspects of your financial history.
To make sure this process runs as efficiently as possible, you should understand what is expected of you from the lender, and don’t try to hide any less-than-perfect components of your financial records from the underwriter.
Common Underwriting Pitfalls And How To Avoid Them
Before entering the underwriting process, there are a few additional aspects of your finances that you should check on to ensure that everything goes smoothly and that you aren’t faced with any unpleasant surprises that could impact your ability to get approved.
Cash Deposits In Your Bank Account
Underwriters typically need to review bank statements with at least 60 days of transaction history. If you have cash savings outside of your bank account, be sure to deposit any funds you plan to use several months before you begin your loan application.
Outstanding Balances With The IRS
Don’t worry – owing taxes doesn’t automatically disqualify you from getting a loan, but it can pose a problem that slows the process. Underwriters often need to request tax return transcripts from the IRS to confirm whether a client owes money to the IRS and whether a payment plan is in place. You may have to reevaluate loan options depending on the situation.
If you don’t have a payment plan set up, make sure the balance you owe is paid off before you begin your loan application or that you’re able to prove to your underwriter that you have the assets to pay it off. If you’re in the middle of repaying the balance, make sure you’re able to provide at least 3 months’ worth of repayment receipts to your underwriter.
Can I Address Past Financial Difficulties With The Underwriter?
Sometimes. Some mortgage loan products allow for manual underwriting. That means that, if an automated underwriting algorithm rejects your mortgage application, a human underwriter will review it to see if there was any way to approve it regardless. Unfortunately, not all mortgage programs allow for the exercise of a human being’s discretion, and your numbers either add up, or they don’t.
However, many loan products offer the ability to communicate directly with an underwriter by writing them a Letter of Explanation. If you can explain in the letter why you had those financial problems – a foreclosure or a bankruptcy, for example – and how you’ve resolved the underlying situation, it’s entirely possible that your application will be approved, albeit at a higher interest rate.
The Bottom Line
As you begin the work to get approved for a mortgage, it’s important to understand everything you’ll need to have prepared for the underwriting stage of the approval process. Do your research ahead of time and talk to your lender to get a sense of the information and materials you’ll need to provide, and you’ll be far more likely to get through the process without a hiccup.
Ready to apply? Start your application process with Rocket Mortgage® today!