When you apply for a mortgage loan, your application goes through an underwriting process where the bank evaluates your creditworthiness and ability to repay the loan. Underwriters carefully analyze your income, assets, debts, and credit history to determine if you qualify for the loan and pose an acceptable level of risk to the lender.
What is mortgage underwriting?
Mortgage underwriting is the process a lender uses to assess a borrower’s eligibility for a home loan. The underwriter reviews the borrower’s credit report, income, assets, debts, and other financial information to determine if the borrower meets the lender’s guidelines for extending credit.
The underwriter’s role is to evaluate the borrower’s ability and willingness to repay the mortgage loan. They must balance risk and reward for the lender – approving borrowers who are likely to pay back their loans while declining those who may default.
Underwriting helps protect lenders from taking on too much risk. It ensures prudent lending practices that allow lenders to remain financially stable so they can continue providing mortgage loans.
What do underwriters look for?
Underwriters scrutinize several key areas when reviewing a mortgage application:
Income
Stable and sufficient income is one of the most important factors in underwriting. Underwriters verify your income sources and amounts by requiring pay stubs, W-2s, tax returns, and bank statements. Self-employed borrowers may need to provide additional documentation such as business tax returns. Underwriters need to see that your income adequately covers your monthly mortgage payment and other debts.
Assets
Underwriters review your assets, including checking and savings accounts, to ensure you have enough funds for a down payment and closing costs. Lenders typically want to see you have two to three months of mortgage payments available after closing. Assets also indicate your overall financial stability.
Debts
Your debts, or liabilities, are reviewed to determine your total monthly expenses. Underwriters look at your credit report to see all outstanding debts like credit cards, auto loans, student loans, child support, and alimony. They want to make sure your total monthly debt payments, including the new mortgage, are not excessive relative to your income.
Credit history
Your credit report provides a detailed view of your borrowing and repayment history. Underwriters evaluate factors like payment history, amounts owed, length of credit history, new credit accounts, and types of credit used. In general, a higher credit score indicates to lenders that you responsibly manage debt.
Down payment amount
The down payment indicates your financial stake in the home. Underwriters assess your down payment amount relative to the purchase price and loan type. In general, larger down payments represent less risk for lenders.
Property
Underwriters also look at the property you wish to purchase. They confirm the property appraisal to ensure the home’s value adequately supports the loan amount. The property’s condition, location, and market value trend are also evaluated.
What debt-to-income ratios do lenders look for?
As part of reviewing your debts, underwriters calculate your debt-to-income (DTI) ratios. DTI ratios compare your monthly debt payments to your monthly gross income. Two ratios are calculated:
- Front-end DTI: Total monthly housing expenses / total monthly gross income
- Back-end DTI: Total monthly debt payments / total monthly gross income
Lower DTI ratios indicate less financial risk. Here are typical DTI requirements by loan type:
| Loan Type | Front-end DTI | Back-end DTI |
|---|---|---|
| Conventional | 28% | 36% |
| FHA | 31% | 43% |
| VA | 41% | 41% |
| USDA | 29% | 41% |
What credit score is needed?
Minimum credit score requirements vary by loan type:
| Loan Type | Minimum Credit Score |
|---|---|
| Conventional | 620 |
| FHA | 500 |
| VA | No minimum |
| USDA | 640 |
In general, the higher your credit score, the better mortgage terms you can qualify for. Scores below 620 may require higher down payments or other credit enhancement.
How are income sources verified?
Underwriters verify borrower income using documents directly from the source. Here are some common ways employment and non-employment income are verified:
Employment income
- Pay stubs showing year-to-date earnings
- W-2 tax forms for the last two years
- Written verification of employment and salary from the employer
- Bank statements showing regular payroll deposits
Self-employment income
- Business tax returns for the last two years
- Profit and loss statement
- 1099 forms confirming independent contractor income
Other income sources
- Investment/interest income – tax returns, account statements
- Rental income – signed leases, tax returns
- Retirement/Social Security – award letters, bank statements
- Child support/alimony – court orders, bank statements
What documents are needed for underwriting?
In addition to income and asset documentation, underwriters typically require:
- Completed loan application (Form 1003)
- Credit report
- Property appraisal report
- Purchase contract if buying
- Homeowners insurance information
- Identification such as driver’s license
Self-employed borrowers may need to provide business tax returns and a profit/loss statement. VA and USDA loans require certificates of eligibility. The lender may request additional documentation depending on your specific financial situation.
How long does underwriting take?
The underwriting time frame depends on factors like:
- Borrower’s financial complexity
- Responding to underwriter requests
- Underwriter’s workload and department resources
- Obtaining third-party verifications
The underwriting process typically takes between 2 to 4 weeks for well-qualified borrowers with all documentation submitted upfront. It can drag on longer if the underwriter must request more information from you or your employer.
What loan scenarios may face underwriting challenges?
While underwriters review each application individually, here are some general situations that could lead to underwriting challenges and additional scrutiny:
- Self-employed borrowers – more documentation required
- Frequent job changes – income stability questioned
- Nontraditional credit – higher down payment often needed
- High DTI ratios – ability to repay questioned
- Low credit scores – higher risk of default
- Applying for multiple new credit accounts
- Paying off accounts before applying – can seem like manipulation
- Insufficient reserves after closing
That said, underwriters understand that every borrower’s situation is unique. While these factors may raise questions, they do not automatically disqualify you from getting approved. Working closely with your loan officer to explain your circumstances can help.
What happens if you are denied?
If your mortgage application is denied, don’t panic. Here are some steps to take:
- Ask for details – Request the specific reasons for the denial from your loan officer. Understanding the factors that led to the decision is key.
- Review credit reports – Check reports from all three bureaus for any errors that need correction.
- Improve your finances – Take steps to pay down debts, increase your income, or save more for a larger down payment.
- Ask about alternatives – Discuss other loan types or programs you may qualify for with your loan officer.
- Build your case – Gather documents and write a letter explaining any mitigating circumstances.
- Appeal the decision – You have the right to formally appeal the denial and have another underwriter re-review your application.
With guidance from your loan officer, many initially denied borrowers are ultimately able to obtain home loan approval.
Conclusion
Mortgage underwriters take a detailed look at your finances to evaluate if you meet the lender’s requirements for extending credit. While underwriting is standardized in many respects, each applicant presents a unique situation. Working closely with your loan officer and providing complete documentation can help facilitate the process. Underwriting exists to create responsible homeownership – not prevent it. So don’t get discouraged if your first attempt is denied. Persistence and understanding the factors underwriters evaluate can help you achieve your dream of homeownership.