Mortgage lending is like any other business in the sense that there is a lot that customers do not see. Yes, you are fully aware that getting a mortgage involves filling out and submitting an application. You know a loan officer reviews your application and renders a decision. But there is a lot more that goes on behind the scenes – like underwriting.
Mortgage underwriters are tasked with reviewing loan applications, checking all the relevant data, and ultimately deciding whether or not to approve a loan. And believe it or not, underwriting is not a simple job. It involves a lot of complex data that requires the right knowledge and experience to analyze.
CityHome Collective, a real estate brokerage and design firm in Salt Lake City, says that underwriters ultimately make the decision to approve or deny a mortgage. They say underwriters govern their decisions based on what are known as the ‘three C’s of underwriting’.
#1 – Capacity
Lending money is always risky. Banks risk handing over large amounts of money that may not be repaid. In order to mitigate that risk, they thoroughly research a borrower’s capacity. They define capacity as the means by which a loan will be repaid. Think of capacity as the means to repay supported by the resources to do so.
A borrower’s capacity can be understood as the relationship between his income and debts. As such, the most important factor in this regard is something known as the debt-to-income ratio. A borrower’s capacity to repay is directly tied to this ratio.
Imagine a home buyer with a monthly income of $5,000. Between his regular monthly bills and paying off other forms of credit, he spends $4,000 per month. That leaves him $1,000 to cover his housing expenses. Subtracting a few hundred dollars for property taxes and homeowner’s insurance leaves him with $700 to make a mortgage payment. That is his capacity.
#2 – Credit
The second thing underwriters look at is credit. They want to know how the borrower handles debt. Does he pay his bills on time? Does he use credit cards responsibly? Are there any past instances of defaults or judgments? These sorts of things are represented in the borrower’s credit score and history.
Also included in the credit aspect is something known as credit utilization. This is a measurement of how much money the borrower owes as compared to how much credit is available to him. For purposes of simplicity, think of a credit card with a $1,000 limit. If the borrower’s outstanding balance is $300, his credit utilization is 30%. He is borrowing only 30% of what has been made available to him.
#3 – Collateral
There are two types of loans one can obtain: secured and unsecured. A secured loan is a loan that is backed by some sort of collateral. Mortgages are secured loans because they are backed by the houses being purchased. In light of that, mortgage underwriters look at the value of the collateral in question.
An underwriter wants to know that the home being purchased is worth more than the amount being borrowed. This is the purpose behind having a home appraised. The bank wants to know that the property, in its current condition, has a high enough market value to cover the loan should the buyer default.
Now you know the three C’s of underwriting. Whether you were to purchase a home through a CityHome Collective realtor or an agent in some other city, your mortgage lender would utilize the same underwriting process. It is just the way the mortgage lending industry is set up.