Underwriting! How’s that for a big, portentous word that may or may not mean what you think? If you’re still in the dark on this one, don’t fret. This blog will define “underwriting” as it relates to mortgage finance and walk you through the basics.
Underwriting can mean more than one thing. For our purposes, underwriting is the process by which a person or institution assesses the risk of a given lending opportunity. The person who makes the final decision regarding said risk and whether or not to offer a loan is called the underwriter.
Another definition of underwriting, and one that is used somewhat loosely as a marketing term, is the financial support offered in return for advertising. Underwriting can also refer to a sponsorship or a donation.
For the rest of this blog, however, underwriting means just this: assessing risk and determining whether, and under what conditions, a lending institution is willing to accept said risk.
The basics of underwriting come down to four C’s: Credit, Capacity, Collateral, and Character. Each one tells a piece of your story and helps the underwriter to determine whether your credit risk is good, bad, or somewhere in between.
Credit: Your credit score is clue number one with respect to risk. Credit scores are useful for an underwriter, as are the many other details on your credit report. Buyers who want a low interest rate know that being proactive pays. Review your report with a fine-toothed comb so that you can take a hard look at any poor choices (and hopefully change them!) Also, this is your chance to dispute any incorrect information before beginning the loan process. To obtain a free copy of your report, go to www.annualcreditreport.com. The free copy does not include your credit score but does include everything else such as payment history, open accounts, balances, public records, and credit inquiries.
Capacity: Most borrowers will be asked to show proof of income. If you’re taking on a new monthly payment, then you’ll need to show the underwriter that you have a way to pay it back. Income documentation may include W-2 or 1099 forms and paycheck stubs. Proof of direct deposits and/or bank statements showing passive income might also be helpful to an underwriter.
Collateral: When it comes to mortgages, the collateral is the house itself. This is why lenders require an appraisal from a licensed professional. The underwriter needs to know if the property has enough value to support the requested loan amount. This way, if a borrower defaults (i.e. completely quits paying their mortgage) the lender can exercise the right to foreclose on the collateral (the house) and recover some or all of the funds lost on the defaulted loan.
Character: Now is a good time for some self-examination. How have you handled responsibility in the past? Do you typically pay things on time? Are there any previous judgments, liens, or bankruptcies on your record? Time helps to heal these financial wounds, but it’s a slow recovery. These and other credit blemishes may still show up on your credit report for years after you’ve settled them. A history of poor financial character could cause your lender to decline your loan request or to offer financing but with a higher interest rate.
Conversely, if you’re a model citizen with timely payments and a stellar report from your landlord, the underwriter may be willing to cut you some slack with respect to the first three C’s. Character matters.
Down payment Assistance Programs
Some buyers have their four C’s in order but find themselves lacking the funds necessary to make a 10 to 20 percent down payment on a home. Enter the Down Payment Assistance Program (DPA). Most states offer loan or grant programs that can cover the cost of a down payment, thereby turning the related loan applications into more attractive credit risks. The capacity section of the four C’s increases significant when a DPA is attached.
DPAs will require their own set of conditions. DPAs are underwritten separately from the primary loan product and by an institution other than your main lender. Be prepared to show proof of income, assets, and to meet other conditions again if you would like to pursue one of these programs. DPA stipulations are similar to those encountered during a loan application, but with one major difference: Too much income will disqualify you.
If you’re interested in a DPA and want to know if you could qualify, start by visiting the Department of Housing & Urban Development’s website at https://www.huduser.gov/portal/datasets/il.html.
What to Do If Your Credit Score is Too Low
In this case, as with any of the four C’s, follow your loan professional’s advice. Each case is unique and there are many ways that a borrower can make themselves more attractive in terms of credit risk. The lending team at Ruoff is here to guide you and to respect your questions and your privacy. The sooner you inquire about pre-approval, the sooner you can get started on the road to underwriting success!