Underwriting: Everything You Need To Know To Get Your Dream Home
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.
This process is called underwriting, or mortgage approval. For many people, applying for a mortgage is a stressful and somewhat mysterious process, but we’re here to help clear things up.
Keep reading to learn more about underwriting and how to optimize your experience.
- Underwriting is the process of verifying and analyzing the financial information you provide to your lender.
- There are three types of underwriting: loan, insurance and securities.
- Underwriters will analyze your IPAC – income, property, assets and credit – to determine your risk.
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.
If you’re getting a mortgage, it’s the job of the underwriter to make sure that all the information you have provided is true and accurate. To do this, the underwriter assigned to your application will:
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 major 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 primarily 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 would 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.
Finally, 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 showing how much other debt you owe, in the form of car payments, student loans, 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.
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 at hand as you begin to work with your underwriter.
If you’ve previously rented property, some mortgage programs require you to provide records of your rent payment history for at least 12 months 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 to avoid scrambling to compile the necessary materials at the last minute.
All loans require some form of underwriting, and the most common type of loan underwriting is for mortgages. As we discussed above, a mortgage underwriter assesses the level of risk you present to a potential lender by looking closely at your income, property, assets and credit.
This in-depth analysis of your financial picture will help them determine whether to approve or deny your loan application. If they approve you without conditions, there’s nothing else you need to do besides scheduling your closing with the lender. However, you may need to provide more information if your approval comes with conditions or if your application is suspended.
If they deny your mortgage application, you first need to find out why. Lenders are legally required to tell you why an underwriter denied your application if your credit played a role. If you aren’t sure about the reason, contact your lender directly so you can figure out your next steps.
Insurance underwriting is the same concept as loan underwriting, but it instead assesses the risk of a person seeking life, health or property insurance. With life insurance underwriting, for example, an underwriter will assess the risk of a potential policyholder to the lender by evaluating their age, health, medical history, occupation, lifestyle and other factors.
Securities underwriting is a bit different, as it involves assessing the risk and price of certain securities – most often through an initial public offering (IPO). The securities underwriter, or investment bank, helps a company raise money from investors by determining the value and risk of that company’s bonds or stocks, then selling the securities on the market.
If all your paperwork is finished and all 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 the lender expects from you, and don’t try to hide any less-than-perfect components of your financial records from the underwriter.
Deposit Cash Funds Early
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.
Pay Off 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 and whether a payment plan is in place. You may have to reevaluate your 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.
Be Honest About Your Finances
If you’re dishonest about any aspect of your financial history or current situation, your underwriter will find out eventually, and it could slow down the underwriting process. For this reason, it’s best to be honest and upfront about your finances from the start. If there’s anything you suspect could raise a red flag on your credit report, for example, provide a note with an explanation for your underwriter. This act of good faith can help ensure you have a smooth experience.
Still unsure about underwriting? We have answers to commonly asked questions about the underwriting process.
What Does Loan Underwriting Mean?
Loan underwriting is when an underwriter assesses your risk to the lender if they were to offer you a loan. This can include mortgage/real estate loans, car loans or personal loans.
What Does the Underwriter Look For?
Underwriters look for indicators that you have an overall healthy financial history and that you will be able to make payments on your loan should you lose your primary source of income or default on the loan. They do this by analyzing your income, property, assets and credit.
What Do Underwriters Do With My Financial Information?
As financial experts, underwriters analyze your financial information to assess your risk to the lender. They will review your credit report, bank accounts and statements, tax forms and other financial documents. This helps the lender determine the size of the loan and mortgage rate they might offer you based on your perceived ability to repay it.
Can I Address Past Financial Difficulties With the Underwriter?
Sometimes. While some mortgage loan products have an automated underwriting process, many 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.
If you are able to communicate directly with an underwriter, it’s a good idea to write them a letter of explanation. If you can explain in the letter why you had certain 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.
What Is the Purpose of Underwriting?
At its core, underwriting is about identifying risk. Underwriters use your past financial behavior, data from past transactions and mathematical models to make predictions about your future financial behavior.
Once they’ve determined how much of a risk you present, 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, however, 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.
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 Quicken Loans® today!