Once your offer on a home has been accepted and you have submitted your full mortgage application, there is one final step before you’re home free--the underwriting process. Underwriting is done by an underwriter who has the final say on approving or denying your mortgage. The whole process can take about 30-45 days but depends on each unique situation. The underwriter will verify your identity and scrutinize every aspect of your finances from your bank statements, to tax documents, to pay stubs. They want to know not only your income but your income sources, debts, assets, credit score and expenses, among others. After receiving all the required documents for your loan application, they will verify that you are who you say you are and determine how much of a risk you are to the lender. This process happens even if you are pre-approved for a mortgage.
Approximately, 8% of prospective borrowers get denied for a home loan. And that number may be higher since Covid-19, as many lenders have new qualification requirements. So what are some reasons underwriting would deny a loan?
The inspection is an important step to buying a home. It protects the buyer by alerting them to any hidden problems--minor or major--and gives them an opportunity to back out of the purchase. The buyer should be aware of issues so they can factor in the cost to fix it and decide if they want to live with it or find another home. The inspection could find something as small as a missing deck board or as large as a leaky roof. It’s also important that the buyer be aware of issues that could impact their health and safety, like mold, dangerous wiring, radon, etc...
The inspection is also a requirement of mortgage lenders, as most lenders will not grant a loan without one. The lender’s underwriters look at it from a purely practical and financial standpoint--if the inspection reveals a serious problem like faulty wiring or structural issues, they may deny the loan, because the home is a bad investment. And some loans, like the FHA loan, have requirements that must be met during the inspection, or else the loan will be denied.
Regardless of what you pay for a home, its value is determined by the appraisal. Different from the home inspection, the appraisal is an estimate of a home’s market value, as determined by a trained, licensed appraiser. It is based on location, condition of the home, renovations/amenities, comparable homes in the area and the current market.
Lenders will not give a loan for more than a home’s value. So if a home is sold for more than its appraised value, you will either need to negotiate a new price, abandon the purchase altogether, or pay the difference.
If your credit score is too low, the underwriter might see you as too much of a risk for a loan. If you make payments late and don’t pay in full, that could indicate to them that you will not be a reliable borrower. If you’re applying for a loan with low credit, you may want to take steps to raise it and be extra careful not to miss any payments or do anything that will lower it. And make sure to check your credit score/report beforehand and dispute any errors you find.
The loan-to-value (LTV) ratio tells you how much of your home’s value you are borrowing and directly impacts your loan eligibility and likelihood of getting approved. In the case of LTV ratio, the lower, the better. If it is too high, the underwriter will see you as high risk.
To lower your LTV, you can make a larger down payment, which has many benefits in and of itself. It shows the lender that you can save money; it gives you lower closing costs and interest rates; it keeps you from having to pay for Private Mortgage Insurance (PMI) if you make a down payment of 20% or higher; and it makes your offer more attractive to the seller. If saving for a down payment is a problem for you, there are many Down Payment Assistance programs specifically designed to help buyers with this.
Your DTI ratio is a percentage that determines how risky it is to give you a loan and tells lenders how much of your income goes toward your debt. It is your total monthly debts divided by your gross monthly income. Your debt includes the proposed home loan, rent, credit cards and all other regular payments like alimony and child support. Most lenders mandate that your total monthly debt be less than 50% of your gross monthly income, but the ideal DTI ratio is under 43% to give you the best loan options. If your DTI ratio is high, lenders may think you cannot take on more debt and cannot afford a mortgage.
If you are going to apply for a loan with a lot of debt, you may want to pay off some of your debts first, so you look like a better loan candidate. And once you apply, don’t increase your debt either.
It goes without saying that lenders want to give loans to people who have a stable income. They don’t just value how much income you have, they also want to know that it’s steady every month. If you are recently unemployed or have a history of unsteady employment, the underwriter may doubt that you can reliably make your monthly loan payments. Even starting a new job could have the same effect, as they may question if you’ll last in the job.
Employment-wise, the best thing you can do to get approved for a loan is to stay at your current job or at least wait to apply for a loan until you’ve been at your new job for some time. Either way, be open and honest with your lender, not just for their benefit, but also for yours. You don’t want a loan you can’t pay back anymore than the lender does.
Again, lenders want stability. That applies to money coming in and going out. Any major expense or sudden windfall could be a red flag. The underwriter could be concerned about any large recent payments just as they could be concerned about large deposits. This will make them question where the money suddenly came from, because it could mean you were given a gift or that you took out another loan to pay for your down payment, which would increase your DTI ratio.
Most lenders want borrowers who can show they have enough money saved to cover six months of expenses, including the cost of the loan, the down payment and all your other expenses. If you don’t have enough saved, your application will likely be denied. The lender could also deny your loan if you do not have adequate income to afford the loan.
For borrowers who had a previous mortgage and had missed/late payments or a foreclosure, the underwriter might deem you as too high risk, at least for a considerable amount of time. So if you had a mortgage and made payments on time every month, you will want to show proof.
When scrutinizing your finances, the underwriter will need to see documented proof of your income, funds and assets. As previously mentioned, they will need W-2 forms, pay stubs and other financial documents. If those are not available or if your income is from unverifiable sources, that will not fly. Before applying for a mortgage, be sure to get all your financial documents together, including paperwork for any money you were gifted for your down payment.
Before you apply for a loan, get all your documents and finances in order. If you are denied, it’s not necessarily the end of the line. Lenders must tell you the reason you were denied, so ask! Once you understand the reason your application was denied, you can take steps to increase your chances so you can apply again, such as buying a different home, lowering your DTI ratio, improving your credit, paying off some of your debts and saving more money.