What is Mortgage Underwriting?
Underwriting is the process lenders use to analyze a borrower's finances to determine if they qualify for a mortgage loan. It involves assessing the borrower's creditworthiness, income, assets, debts and other factors to decide whether to approve or deny a loan application.
Underwriting is a critical step in the mortgage process that helps protect lenders from lending to borrowers who may be at high risk of default. While complex, underwriting ultimately aims to ensure loans are only given to borrowers who can reasonably afford to repay them.
The Underwriting Process Step-By-Step
Underwriting typically involves the following key steps:
Loan application - The borrower completes a mortgage application providing information on their income, employment, assets, liabilities and other details. This application forms the basis of the underwriter's analysis.
Credit check - The underwriter reviews the borrower's credit reports and credit scores to assess their creditworthiness. Factors considered include payment history, amounts owed, length of credit history and new credit inquiries.
Verification of income and assets - Documentation is required to confirm the borrower's stated income and assets. This may include recent pay stubs, W-2s, tax returns, bank statements and investment account statements.
Verification of employment - Written confirmation from the borrower's employer verifies their employment status and income. Self-employed borrowers may need to provide additional documentation.
Debt-to-income (DTI) calculations - The underwriter calculates the borrower's DTI, or the percentage of gross monthly income allocated towards total monthly debt payments. Most conventional loans require a DTI of 43% or less.
Appraisal - An independent appraiser estimates the property's market value to confirm the loan-to-value ratio falls within guidelines.
Automated underwriting - Many lenders first run the application through an automated underwriting system such as Fannie Mae's Desktop Underwriter or Freddie Mac's Loan Prospector. These provide a preliminary underwriting recommendation.
Manual underwriting - A loan officer will manually review the entire application, verifications and calculations to provide final approval or denial.
Loan conditions - If approved, the underwriter may impose certain conditions that must be met before final approval, such as paying off specific debts.
Final loan decision - After all underwriting requirements are met, the lender issues a final loan decision - either an approval or denial.
Key Factors Considered During Underwriting
While underwriters analyze dozens of data points, these are among the most significant factors weighing into the final loan decision:
Credit scores - Minimum credit score requirements vary by loan type, but generally scores below 620 indicate higher risk. Scores above 740 often qualify borrowers for better loan terms.
Down payment amount - The larger the down payment, the lower the loan-to-value ratio and thus the better for underwriting. A 20% down payment is ideal.
DTI ratio - Also called the debt-to-income ratio. As noted above, 43% is a common benchmark, but requirements fluctuate.
Loan type - Government-backed FHA and VA loans are more lenient than conventional loans. Jumbo loans for higher amounts face tighter restrictions.
Employment history - Underwriters look for stable employment in the same industry. Frequent job changes or gaps raise concerns.
Income sources - Salaried income from W-2s is simplest to document. Self-employment, commissions and other income sources require extra verification.
Assets and cash reserves - Liquid assets and cash reserves indicate the borrower's ability to cover mortgage payments if income is disrupted. Reserves of 6-12 months are often required.
Property appraisal - The appraised value affects the loan-to-value ratio. A lower appraisal may require the borrower to pay more upfront.
When Do Loans Get Denied in Underwriting?
While underwriting guidelines vary by lender and loan program, here are some common reasons a mortgage may get denied during underwriting:
Debt-to-income ratio exceeds limits
Credit scores or history fall below requirements
Insufficient verified income or questionable income sources
Assets don't meet minimum required reserves
Down payment is less than required
Loan-to-value ratio out of bounds due to appraisal
Undisclosed debts or liabilities found on credit report
Inability to document source of funds for down payment
Application contains significant inaccuracies or inconsistencies
Recent bankruptcy, foreclosure or short sale
Pending mortgage delinquencies or collections
Job loss or employment gaps
Large, recent deposits from unspecified sources
New debts taken on during process
Carefully reviewing your credit reports, compiling financial statements, providing exhaustive documentation and maintaining your current employment are key to avoiding problems in underwriting. Always disclose debts and assets upfront and avoid taking on new obligations before closing.
Getting Approved: Tips for Successful Underwriting
To improve your underwriting chances and get approved:
Maintain a low DTI - Keep total household debt payments under 40% or lower. Pay down revolving balances.
Have a large down payment - Save 20% or more of the home's price for your down payment if possible.
Check your credit - Review credit reports and resolve any errors or issues ahead of time.
Pay down balances - Pay off credit cards, auto loans and other debts to lower your DTI. Pay off collections and disputed accounts if possible.
Avoid new inquiries - Don't open new credit cards or apply for loans leading up to your mortgage application.
Verify income - Gather 2 years of W-2s, recent pay stubs, tax returns and other documentation.
Gather asset statements - Have 2 months of bank, investment, retirement account statements showing required reserves.
Explain sources - If you received gift funds or large deposits, document where they came from.
Stick with your current job - Avoid changing jobs or employers during the mortgage process.
Choose your loan program wisely - Conventional, FHA, USDA, VA and other programs have different requirements.
Following these tips can position you to sail smoothly through underwriting and get your mortgage approved.
The Bottom Line
Underwriting is the make-or-break stage of the mortgage process where your entire financial profile will face scrutiny. While approval is never guaranteed, you can take steps to improve your underwriting chances.
Come prepared with a strong down payment, low DTI ratio, solid credit scores, stable employment history and well-documented assets and income sources. With diligent preparation, you can hope to get the green light and move on to mortgage closing.