Homebuyer Education Series - What Is Underwriting?

What Is Underwriting?

Explaining the Underwriting Process

Did you know that your finances go through a process called underwriting before you can officially get a mortgage? Underwriting is a crucial component of the home loan process because you can't get to closing until your lender's team completes the underwriting for your mortgage. Let's dive in and learn more about the underwriting process.  

What Is Underwriting?

Though it might sound complicated, underwriting simply means that your lender verifies your income, assets, debt, and property details in order to issue final approval for your loan. Underwriting happens behind the scenes, but that doesn't mean you won't be involved. Your lender might ask for additional documents and answers, such as where bank deposits came from, or ask you to provide proof of additional assets.  

What Does an Underwriter Do?

While your future home undergoes an appraisal, a financial expert called an underwriter looks over your finances.  In doing so, they assess the amount of risk a lender will take if they decide to give you a loan. The underwriter helps the lender decide whether or not to grant a loan approval and works with you to make sure that you submit all your paperwork. Ultimately, the underwriter will ensure that you don't close on a mortgage that you can't afford.  

An underwriter can:

• Investigate your credit history. Underwriters look at your credit score and pull your credit report. They look at your overall credit score and search for things like late payments, bankruptcies, overuse of credit, and more.
• Order an appraisal. Your underwriter will order an appraisal to ensure the lender's offer amount for the home matches-up with the home's actual value.
• Verify your income and employment. Your underwriter will ask you to prove your income and employment situation.
• Look at your debt-to-income ratio (DTI). Your DTI is a percentage that tells lenders how much money you spend versus how much income you bring in. You can calculate DTI by adding up your monthly minimum debt payments and dividing it by your monthly pre-tax income. An underwriter examines your debts and compares them to your income.  This step is necessary to ensure you have more than enough cash flow to cover your monthly mortgage payments, taxes, and insurance.
• Verify your down payment and savings. The underwriter also looks at your savings accounts to ensure you have enough savings to supplement your income or use as a down payment at closing.

How Long Does Underwriting Take?

Your mortgage can be just as unique as your financial situation, so the exact amount of time the underwriting process takes will vary on a case-by-case basis. The sooner all of the necessary documentation is in the underwriter's hands, the smoother the process will be, so it's essential to get all requested documentation to the lender promptly.    

What Makes Up the Underwriting Process?

The underwriting process directly evaluates your finances and past credit decisions. During the underwriting process, your underwriter looks at several areas, giving them a complete picture of your financial standing: namely your income, credit, and asset information. Your underwriter will consider your home's appraisal value as well.

Income

Your underwriter needs to know that you have enough income to cover your mortgage payments every month. To prove this, you need to provide three types of documents to verify your income:

• W-2s from the last two years   
• Your two most recent bank statements
• Your two most recent pay stubs  

Are you self-employed, or do you own a sizeable share in a business?

You'll need to furnish a few different documents in place of W-2s: profit and loss sheets, K-1s, balance sheets, and your personal and business tax returns. Your underwriter will also check that your income matches the income you report and verify your employment situation with your employer.  

Appraisal

Appraisals are almost always required when you purchase a home. They protect both you and your lender because they ensure you only borrow what the house is worth. An appraiser will inspect the property, walk through the home, and take pictures and measurements to evaluate its condition and features. The appraiser then compares similar properties by looking for homes similar in location, size, and features. These "comps" need to have sold within the past six months.  They should also be located within a mile of the property unless you live in a rural area. After a professional appraiser places a value on the property, the underwriter compares the appraisal to your mortgage amount. If the home is worth much less than the mortgage, your underwriter may suspend your application. In this situation, you may contest the appraisal, negotiate with the seller to lower the purchase price, or walk away from the property altogether.  

Credit

An underwriter also evaluates your credit score. Your credit score, a three-digit number, indicates how responsible you are when paying back debts. A good credit score shows that you pay back your debts and can also help you qualify for a lower interest rate.

The minimum credit score you'll need depends on what type of loan you're pursuing. Your credit score should be at least 620 if you apply for a conventional loan.

If you apply for an FHA loan, the minimum credit score is 580. Though there is no minimum credit score for VA loans, individual lenders may set their own minimum credit requirements. Your underwriter will also pull your credit report and look at your payment history, your credit usage, and the age of your accounts.

The underwriter looks at your credit report to determine your debt-to-income (DTI) ratio. As mentioned earlier, it's the total amount of money you spend on bills and expenses each month divided by your monthly gross (pre-tax) income. Lenders prefer to see a DTI ratio at or below 50%.

Here's an example of how to calculate DTI: Let's say you earn $5,000 a month. Let's also say you spend $600 a month in rent, $200 on an auto loan, and $300 in student loan payments.

To find your DTI, you would divide $1,100 (the total cost of a month worth of debts) by $5,000. In this example, you have a DTI of 0.22 or 22%.

Asset Information

Your assets can help you qualify for a mortgage because you can sell them for cash if you default on your payments. An underwriter might view your checking and savings accounts, real estate, stocks, and personal property. Since closing can be anywhere from 3% – 6% of the loan price, lenders also use assets to ensure you can make mortgage payments after you pay closing costs.