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 and you being able to pay for that new home.
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 Mortgage 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 make your payments and also to determine if your home will be worth enough to cover your mortgage loan should you default.
What Do Mortgage Underwriters 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 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.
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, the lender 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 any saved assets you may have such as checking and savings accounts, stocks, bonds and proceeds from the sale of 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 enter 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 pay your current and past bills on time. But they also need to understand 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, or your debt-to-income (DTI) ratio, is a strong indicator of future financial difficulty.
After the subprime mortgage crisis contributed to the 2008 financial crisis, lawmakers empowered the CFPB 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 determinant of whether your mortgage application will be approved.
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 risk associated with economic factors and the cost of money generally, and the likelihood that you, as an individual, are likely to repay debt. When you see posted mortgage rates, they are generally 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 have 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.
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 generally offer the ability to communicate directly with an underwriter. If you can explain why you had those financial problems in the first place, and how you’ve resolved the underlying situation, it’s entirely possible that your application will be approved, albeit at a higher interest rate.