Underwriting is when your lender analyzes the final mortgage application to make the decision to give you a loan or not. If the decision is made to go forward with the loan, conditions need to be made. This is a process that you have to go through even if you have been pre-approved for a mortgage. Lenders will consider four criteria, aka “the four c’s of home buying”: Credit, Capacity, Capital, and Collateral. All four of these areas must be satisfied for your application to be approved.
Credit: Possibly the most important factor of the 4 C’s. Your credit score taken from the credit report is the simplest measure of your credit strength. In determining an applicant’s credit score lenders will simply use the middle of the three credit scores reported by the three credit repositories (Transunion, Equifax, & Experian).
Credit scores are heavily influenced by your payment history over the preceding 24 months. Other factors may include the proportion of revolving debt relative to the high credit limits, the number of accounts, lack of credit depth, and many more.
Another factor that becomes part of your credit profile is your housing payment history over the preceding 12 months. This may be reflected in a previous mortgage on the credit report or by verifying rent payments if you don’t currently own a home.
Finally, bankruptcies, judgments, and foreclosures can all negatively impact your credit analysis. Just because you may have any negative marks on your credit report doesn’t mean you won’t get approved for a mortgage. It simply means that you will have to show other compensating factors and/ or may have to accept higher rates and terms.
Capacity: In addition to reviewing your credit, lenders want to analyze your ability to repay the mortgage over time. Capacity is the analysis of comparing a borrower’s income to their debt. The primary tool used for this analysis is a debt-to-income ratio. Simply put, the debt-to-income ratio is the sum of all monthly payment obligations you have (including the potential upcoming housing payment) divided by your gross monthly income.
Capital: Do you have a financial cushion to fall back on if your income is unexpectedly interrupted? Have you shown a pattern and habit of saving money over time? These are important questions to a lender and can be answered by reviewing your capital accounts.
Capital accounts are any account with liquid assets that a borrower could access if need be. The most common forms of capital accounts on a loan application are checking, savings, money market, brokerage, IRA, and 401K accounts.
Usually, the bank will want to verify that you have an amount equal to 2 months’ worth of your total housing payment (including real estate taxes and homeowner’s insurance) saved up in a capital account after they subtract any cash required for down payment & settlement charges. If the mortgage is going to be secured by an investment property or second home the bank may want to see more capital for the applicant.
Collateral: This refers to the property itself. Underwriters consider a home’s appraised value when deciding whether to approve a mortgage application. Property size, location, condition, and the value of nearby homes are just some of the things considered when a house is appraised. If you have passed the first three C’s with flying colors, unfortunately, if a home doesn’t appraise well the final loan may not be approved. This is because collateral ensures that the lender won’t lose their money if you default on the loan.
The Bottom Line: Private lenders may have different practices than traditional banks or other financial institutions. They could be more flexible and willing to consider other factors. You, as the borrower, should be prepared to demonstrate that you meet the criteria of the four C’s to increase your chances of getting loan approval. You should also talk openly and freely to the loan officer as they will be supporting you and want to build your file as favorably as possible.