Basic Mortgage Underwriting Principles
When applying for a home loan, it is important to understand the basic criteria you will be judged on. Lenders want to make sure the borrower has the ability to pay, the willingness to pay, and the appropriate collateral in case they can’t pay. Here is a brief breakdown of the basic criteria evaluated in obtaining a mortgage loan.
Ability to pay
A borrower’s ability to pay is measured by their income, the stability of that income, their assets, the amount of the loan payment, and their other credit liabilities. Standards vary from loan program to loan program, but it’s very common that the lender wants to make sure the borrower makes at least 3 times his monthly mortgage payment. So if the monthly payment is going to be $2000 a month, they want the income to be at least $6000. This is commonly measured as a Debt ($2000) To Income($6000) ratio (DTI). Divide the income by the debt and you get 33%. However, DTI is measured for both the payment and for all of the other credit bills that the borrower makes. So, the income is $6000, the mortgage payment is $2000, their car loan is $700, The Visa is $200, and the Sears card is $100 a month. Add all the debts together ($3000), now divide the income by this total number. In this case, the new DTI is 50%. The two ratios are differentiated by the terms “front” and “back” ratio. 33/50 or a 33 front ratio and 50 back ratio. I used some simple numbers here for clarity. In fact, this is on the high side for an acceptable DTI ratio. 28/36 was long a standard. Advanced underwriting engines have allowed this number to rise. The borrower’s employment history, and their saved assets can also affect how high the DTI can be. Borrowers with money saved for a rainy day and at the same job for the last three years are less of a risk than someone living month to month at a job they just started a few months ago.
Willingness to pay
Some borrowers may have the ability to pay their mortgage on time, but not the willingness. It means they place their standing with the lender as a high priority. This willingness is measured by reviewing the history of the borrower’s current and past credit payment history. This is why a credit report is always ordered and why you must ensure the information on the report is accurate.
Residential Mortgages are usually secured by the real estate. The house you are purchasing is what is securing the home loan. Lenders want the present, or sometimes the near future value of the real estate to exceed the amount of the loan they are funding. This is why an appraisal is always needed to state fair market value of the property. If a borrower is unable, or unwilling to make their loan payments, sufficient collateral gives the lender the option to foreclose, (seize the property). But more importantly, it gives the borrower a chance to sell the home, which avoids the legal and marketing costs of foreclosing, and allows the borrower to recoup the equity they have invested in the home. It’s better for the lender if the borrower can sell the property. Because of this, the value of the mortgage versus the value of the property is also important. This is known as the Loan To Value (LTV) ratio. If the property is worth $100,000, and the mortgage is $90,000, then the property has a 90% LTV. A lower LTV means the borrower has more equity in the home, and less likely to be willing to lose that equity through default.