Mortgage Underwriting: What You Need to Know
Mortgage underwriting is a necessary step in the mortgage origination process and begins when the seller accepts the offer you submitted to purchase a home. Either you or your real estate agent contacts your lender, who then collects the necessary paperwork and sends your loan package to the underwriter.
What is mortgage underwriting?
The mortgage underwriting process is where the lender’s underwriter examines your loan application and finances to determine how likely you, as the borrower, are able to make regular mortgage payments to your lender.
“Underwriting occurs once you’ve completed your mortgage application and all required documents are turned in for the underwriter to review, shares Gregory Keleshian, CEO of Crestmont Capital, a company who offers a diverse portfolio of lending products. “They look at your income, credit history, and your debt obligations to better understand whether you’re at possible risk of defaulting on your loan or if you’re a sound investment. If you fail to meet specific criteria, such as low credit score, the debt-to-income ratio (DTI) is too high, the Loan-To-Value Ratio (LTV) is too high, or your employment status has recently changed, the underwriter can decline your application.”
How the loan underwriting process protects lenders
Mortgage lenders – credit unions, banks, and private mortgage companies – must meet requirements developed by the Consumer Financial Protection Bureau (CFPB) to ensure fair and transparent treatment of borrowers. To treat you fairly, lenders also need to protect their interests with a robust approval process before they can fund your loan. The process protects borrowers and lenders from bad loan practices.
“Underwriters are a critical piece of the mortgage lending puzzle,” says Leo Loomie, EVP COO at Streamline Mortgage Solutions, Inc., mortgage brokers serving Florida. “They’re experts at assessing your financial situation to understand how much risk a lender will assume if they decide to give you a loan. The underwriter will follow guidelines put in place to protect you from taking out a mortgage you can’t afford and have the authority to deny the loan if they determine that to be the case.”
What does the mortgage underwriter evaluate?
“A mortgage underwriter will conduct an analysis on a credit package for a prospective borrower,” states Susan Milazzo, CEO of California MBA, the leading advocate for the industry in the largest mortgage and real estate market. “This consists of a review of the following criteria: your income, credit score, debt-to-income ratio (DTI), assets like bank accounts and investments, and the appraised value of the home you plan to purchase. Depending on the type of loan and purpose of the loan an underwriter can take anywhere from 2-3 hours to complete an initial review of a credit package. Once all the questions are answered, and conditions are fulfilled, the underwriter provides a “Clear to Close” on the file and moves it to the closing department.”
The underwriter needs to know that you have enough income to cover your monthly mortgage payments. They verify the income you report and your employment status with your employer.
Your credit score is a three-digit number that indicates how you manage and pay back debt. A good credit score shows that you consistently make debt payments on time. The better your score, the better your interest rate. Depending on the type of loan, you need a minimum credit score of 580 (for an FHA loan) to 620 for a conventional loan. Underwriters also evaluate your credit report to examine your payment history, credit usage, and how long you’ve had your accounts open.
Debt-to-income ratio (DTI)
To evaluate your ability to repay your mortgage, the underwriter compares your monthly debt and recurring expense obligations to your monthly income to arrive at your debt-to-income ratio. Lenders prefer to see a DTI ratio at or below 43%.
Most mortgage lenders require a home appraisal as part of the home loan process. The appraisal protects you and your lender by ensuring you borrow no more than the home is worth.
The appraiser evaluates the condition and features of the home you want to buy and compares it to similar properties sold recently, also known as real estate comps. Comps are homes in your immediate area that are similar in size and features. They must have sold within the past six months and typically within a mile of the property.
Your assets – stocks, real estate, personal property, life insurance, and funds in checking and savings accounts – can help ensure your mortgage approval. Your lender will look for adequate funds and liquid assets to cover closing costs, which typically come in at 3 – 6% of the loan amount.
What information do I need for mortgage underwriting?
1) Proof of income (W-2) – If you work a regular payroll job, you can provide W-2s from the last two years. If you work cash jobs, such as an electrician, massage therapist, mechanic, photographer, or others, you need to provide proof of cash or direct deposits. If you’re self-employed, you need to provide profit and loss statements, K-1s, balance sheets, and two years of personal and business tax returns.
2) Tax returns – If you are an employee, your most recent tax return is sufficient. Self-employed people need to provide business and personal tax returns for the past two years.
3) Assets statements – This includes bank statements, life insurance, investment account statements, and retirement account statements. Your lender will ask for a statement for any account you have money deposited.
4) Credit report – Your lender will pull a specific report for mortgages, different from a consumer report. They may charge you a fee for this report. Your lender may also ask about any reported credit issues to determine if there are any errors on your report.
5) Gift letter – Your lender will need a gift letter to document any funds you receive as a gift from friends or family to purchase your house. All such money used in a home purchase must be “seasoned” in the account for a minimum of 60 days with no debits. Otherwise, it could indicate that you received a second loan for a down payment or closing costs, which goes against your DTI.
6) Photo ID – You need to provide a copy of your driver’s license, passport, or other government-issued ID to confirm your identity. A work visa also qualifies.
7) Rental history – You may need to prove you paid rent for the past year. Your landlord can provide your lender with a documented payment history. This proof can also be in the form of duplicated or canceled checks.
4 steps to expect during a typical mortgage underwriting process
1) Completing the application – This process can involve filling out a form online, meeting face-to-face or by phone, or using a lender’s app.
2) Processing your application – Your lender’s processing team reviews your documents and orders the home appraisal and any additional documentation necessary for the underwriter. The lender’s processing ensures your file is as complete as possible before submitting it to the underwriter. Your lender may contact you with questions to verify the information you provided. When all documentation is complete, the underwriter will review your loan package.
3) Mortgage underwriting – This process determines if your loan application will be approved or denied. Once you have final approval, your loan package moves on to the lender’s closing department.
4) Closing – Ideally, your lender will submit your approved loan package to your real estate attorney or title company as quickly as possible so you can review all of your closing documents in advance of closing. It’s important to go over all closing disclosures to ensure the numbers are correct before closing.
Potential underwriting outcomes
Ultimately, the mortgage underwriting process will result in:
In this case, the underwriter deems the buyer is wholly qualified for the loan amount and is trusted to pay it back, no questions asked and no additional conditions required. This outcome is fairly rare, but it can happen.
This is the most common mortgage underwriting outcome. If a loan is conditionally approved, the underwriter says we’ve got a deal if certain detailed conditions are met before closing. Additional details about your financials or the property—such as the appraisal and title reports—may still be needed before you’re fully approved for closing.
A suspension is most likely the result of missing or poorly prepared documents. The suspension puts approval in standby mode. If the borrower can provide further documents, then the approval proceeds. If not, the application is denied. Ask your lender to advise you on how to fix any issues so you can reapply.
The underwriter can reject the loan application if there is a high risk to the lender. Loan denial, like the suspension, is not permanent. Your lender can advise you on how to improve your financial situation and when you can reapply.
How long does it take for mortgage underwriting and final approval?
Mortgage underwriting can take anywhere from two weeks to 45 days to complete. This timeline depends on how busy lenders are and how active the local housing market is.
“Much of the processing time for a home loan is taken up by underwriting,” states Lendgo, an online platform that connects borrowers to lenders. “Lenders verify your assets, check your tax returns and credit reports, and comb through a lot of the same documentation you provided when you pre-qualified for the loan, this time with a laser focus on your creditworthiness. Underwriters are notoriously cautious. Their decisions can be audited, and if they approve too many questionable loans, they risk their job. Therefore, they err on the side of caution.”
Common reasons underwriters deny mortgage loans
The loan package you submit must be complete, up to date, and ready for the underwriter. If not, you risk delaying your closing date or a denied mortgage application. Here are the eight common reasons underwriters deny mortgage loans:
1) Loan-to-value ratio (LTV) is too high – Lenders cannot issue a loan for more than a house is worth. If the house value comes in lower than the amount of the loan you’re applying for, your lender cannot approve a mortgage. You can reduce the LTV by having a larger down payment than your loan type requires.
2) Credit score is too low – A low credit score indicates a high-risk investment for the lender. It may suggest to the lender that you may have trouble handling the responsibility of the loan and might be unable to make payments on time.
3) Debt-to-income ratio (DTI) is too high – The DTI ratio helps lenders determine if the borrower can take on more debt. If you have a high DTI, you may not be able to afford your mortgage, especially if you incur large and unexpected expenses.
4) Recent change to employment status – Lenders like to see financial stability; it shows your potential to afford mortgage payments. If you’ve had a recent job change, a lender might question your employment stability and whether you can maintain regular mortgage payments. If you leave a job, lose a job, or accept a lower-salary job, it can affect your loan approval. If you get offered a better position during the underwriting process, ask your lender how it will affect you.
5) Unusual bank account activity – Large deposits can raise a red flag with your lender if they’re within two months of applying for your loan. They indicate that you took out a separate loan for closing costs or down payment, which affects your DTI. Lenders always verify that you have funds available to pay closing costs, taxes, insurance, and your down payment, as well as mortgage expenses for up to 6 months.
6) Problems with the property – If an appraisal or home inspection uncovers a major issue, like a bad foundation or roof that needs replacing, the loan may be denied because the home is seen as a bad investment.
7) Appraisal is too low – If the home appraisal value comes back lower than the purchase price, you’ll either need to pay more out of pocket or negotiate with the seller for a lower purchase price. The lender will deny your loan if you can’t do either.
8) History of missed mortgage payments – If you have late or missing payments from a previous mortgage, your underwriter may not feel it’s worth the risk to approve your new mortgage. They want to see evidence that you paid your mortgage on time.
“The mortgage underwriting process is often portrayed as a mysterious procedure where the potential homebuyers cross their fingers, hoping for the best,” says AIME, a community of independent mortgage experts. “Three of the most common reasons why mortgage applications are denied include a loan officer without proper training and operational knowledge, borrowers completing large transactions (i.e. buying a new car) or opening new credit, and receiving a low appraisal.”
To avoid loan rejection, AIME suggests working with a local mortgage broker. “Loan rejection can be avoided by opting to work with a local mortgage broker that relies on their reputation to earn business, avoiding large purchases that will affect the debt-to-income ratio (DTI), and working with an experienced real estate agent, especially in a market of high home values.”
The bottom line
While many things beyond your control could derail the mortgage underwriting process, there are ways to improve your chances of a smooth underwriting experience.
Don’t hesitate to ask your real estate agent or lender questions if you’re feeling confused about home-buying jargon or any underwriting steps. Also, be upfront if you think there may be issues with your underwriting paperwork. If the underwriter requests more paperwork, promptly return requested documents and sign disclosures. Avoid major last-minute purchases or applications for credit, and do not deposit large amounts of cash. Continue making the minimum monthly payments on your consumer debt to avoid any late or missing payments, and continue to make timely rent or mortgage payments.
Be proactive and make sure you’re in a good place financially before applying for a mortgage. Sufficient funds, a stable job, and a strong credit score can help an approval go smoothly. Once the underwriter signs off, your mortgage lender has the green light to offer you a home loan. Be prepared and think ahead.
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