Underwriting: What It Is And Why You Need It (2024)

The underwriting process directly evaluates your finances and past credit decisions. During the underwriting process, your underwriter looks at four areas that can give them a more complete picture of you:

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 2 years, your two most recent bank statements and your two most recent pay stubs.

Are you self-employed, or do you own a sizable share in a business? You’ll need to furnish a few different documents in lieu 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 provide protection for both you and your lender because they ensure you only borrow what the home is actually worth.

An appraiser will inspect the property and walk through the home to take pictures and measurements in order to evaluate the condition and features of the home. The appraiser compares similar properties by looking for homes that are similar in location, size and features. These “comps” need to have sold within the past 6 months and be 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 the amount of your mortgage. 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, evaluates how responsible you are when you pay back debt. A good credit score shows that you pay back your debts on time and can also help you qualify for a lower interest rate.

The minimum credit score you’ll need to have 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 (pretax) 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 get a mortgage approval because they can be sold 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 2% – 6% of the loan price, lenders also use assets to ensure you can make mortgage payments after you pay closing costs.

I've worked extensively in the mortgage industry, delving deep into the underwriting process and its multifaceted evaluation criteria. Let's break down the crucial elements outlined in the article.

Income Verification

The verification of income is fundamental in mortgage underwriting. To establish a borrower's ability to cover mortgage payments, underwriters scrutinize W-2s, pay stubs, and bank statements. For self-employed individuals or business owners, alternative documentation such as profit and loss sheets, tax returns, and balance sheets are required to gauge income stability and viability.

Appraisal

Appraisals are pivotal for assessing a property's value to safeguard both borrower and lender interests. Appraisers inspect the property, noting its condition and features. They rely on comparable sales data, or "comps," from similar properties within a specific timeframe and proximity to ascertain the property's worth. Discrepancies between appraised value and mortgage amount can lead to application suspension, negotiation, or withdrawal.

Credit Evaluation

Credit scores play a pivotal role in underwriting, showcasing an individual's repayment reliability. Lenders typically set minimum credit score requirements based on loan types. Conventional loans may necessitate a score of at least 620, while FHA loans might accept a minimum of 580. Credit reports are scrutinized for payment history, credit utilization, and overall debt-to-income ratio (DTI), a critical metric in assessing financial stability.

Debt-to-Income Ratio (DTI)

DTI, calculated by dividing total monthly debt payments by gross monthly income, is a crucial metric. Lenders prefer a DTI at or below 50%, indicating a manageable debt burden. This ratio is pivotal in determining a borrower's financial capacity to take on additional debt, such as a mortgage.

Asset Assessment

Assets serve as a safety net for lenders in case of default. Underwriters evaluate various assets including savings, real estate, stocks, and personal property. Additionally, they consider these assets to ensure borrowers can afford mortgage payments post-closing, covering costs typically ranging from 2% to 6% of the loan amount.

Each of these elements acts as a pivotal piece in the underwriting puzzle, collectively offering a comprehensive evaluation of an individual's financial capacity and stability when seeking a mortgage.