What is underwriting?
You hear it all the time when it comes to the home loan process: underwriting. It’s a process that seems to takes forever, and most people that are in the middle of one are sweating bullets, just waiting for their green light (read: approval.) But what is underwriting? Why is it so scary? Who does it? And why can it take SO LONG? We’ve got some most of the answers for you. If you want the fast facts, there’s a TL;DR (too long, didn’t read) summary at the end of the article.
What is underwriting?
“Underwriting is when you have to hold your breath, cross your fingers, and hope you don’t get any bad news from the lender. It’s the final and most intensive examination of your mortgage application package. If you clear the mortgage underwriting process, it’s all downhill from there.” 1
Okay, okay… That’s doesn’t really explain what underwriting is, so here’s the actual definition:
“Underwriting is a process during which mortgage lenders assess the eligibility of potential borrowers. In short, the lender wants to ensure that the borrower meets all of their guidelines in terms of income, debt, credit and collateral. The underwriter will also ensure that the borrower meets any secondary guidelines and requirements, such as FHA, VA, Freddie Mac, etc.” 2
Why does my loan have to meet FHA, VA or Freddie Mac requirements?
Guidelines were established by Freddie Mac, Fannie Mae, and the FHA or VA to generate conforming loans because “most loans today are sold to Fannie Mae, Freddie Mac, the VA, or the FHA. Lenders must abide by the underwriting rules set by those organizations if they wish to sell the loans…” 3
Who is the underwriter and what do they look for?
“Underwriters are like real estate detectives. It’s their job to make sure you have represented yourself and your finances truthfully…” 4 It’s their job to protect the lender.
“An underwriter is an entity, typically a company, that is accountable for analyzing and assuming the risk of another entity. Underwriting typically happens behind the scenes, but is an important aspect of mortgage approvals” 5
The underwriter reviews all of the documents the borrower has provided to their lender, including W-2’s, tax returns and bank statements. They’re going to verify the borrower’s employment a few times. The underwriter is going to check the 3 C’s:
1) Capacity — Do you have the resources and means to pay off your debts?
The first question a mortgage underwriter asks is: can the borrower repay the mortgage? Underwriters determine the answer by analyzing and reviewing the borrower’s employment, income, debt, and asset statements.
In particular, underwriters will take a close look at your debt-to-income ratio. They want to see that you have enough money to fulfill your current obligations as well as your new mortgage. Underwriters will also verify the state of your savings, checking, 401(k), and IRA accounts. They want to make sure that if you lose your job or become ill, you will still be able to pay your mortgage.
2) Credit — Do you have a solid re-payment and credit history?
Your credit is perhaps one of the most important factors in the loan approval process. Your credit report will reflect how you have handled and managed to repay past bills (car loans, student loans, and home equity lines of credit). It will also predict your ability to make the proposed mortgage payments on time and in full.
3) Collateral — What is the value and type of property being financed?
An underwriter wants to make sure a loan amount does not exceed a property’s value. Otherwise, a lender may not be able to recover a loan’s unpaid balance, in the case of a default. This is why an underwriter orders a home appraisal. This report will assess a home’s current worth and safeguard a lender from lending too much money.
In addition, underwriters will also review the type of property you wish to purchase. Why is this? Well, not all homes have carried the same risks for lenders in the past. For example, many lenders consider an investment property a more risky investment than an owner-occupied home. Lenders assume that in a difficult financial situation, borrowers would more quickly walk away from an investment property than from their primary residence.
“The title company will research the history of the property, looking for encumbrances such as mortgages, claims, liens, easement rights, zoning ordinances, pending legal action, unpaid taxes and restrictive covenants.
The title insurer then issues a policy that guarantees the accuracy of the work. Your lender will require a title policy that protects the lender. In some cases two policies are issued — one to protect the lender and one to protect the property owner.” 6
If the borrower is purchasing property in a flood zone, the underwriter needs to know so they can verify the borrower has flood insurance. 7
Checking the 3’s C’s will result in one of three outcomes:
The loan will be approved without any conditions
The borrower will receive a “conditional approval” meaning that the borrower has to meet a few more conditions before final approval. Bank transactions or credit issues that need clarification could be the cause of a yellow light. The underwriter might require the borrower to submit a letter and any supporting documents to clarify the issue, after which the underwriter will (1) clear the loan for closing, (2) give the borrower additional follow-up conditions, or (3) reject the loan for some reason
The loan has been turned down for some reason determined by the underwriter.
Why did I go through the preapporval process if that’s not a guarantee?
A preapproval is a great place to start! It gives you a price range, and makes sure you can afford the homes you’ll be looking at. However, the underwriter wants to double and triple check the information you provided for your preapproval, just to make sure all of that is in good standing.
Below are the most common items that would result in a yellow or red light.
- Changing employers. If your lender knows about the change before, and you’re staying in field, and your new employer can verify your new income, you might be in the clear.
- A [new] negative item on your credit. You don’t need perfect credit to buy a home, but a negative item that wasn’t there for your preapproval is going to be a huge red flag.
- Incurring new debt. Taking out a new loan or using a credit card too much is going to throw off your debt to income ratios and raise concern for the lender.
- Change to loan requirements or lender guidelines. If requirements change, ie a 620 credit score now has to be 640, the lender can retroactively deny the mortgage. Just because they can doesn’t mean they will.
- There are issues with the appraisal. If the home doesn’t appraise for the sales price, the buyer and seller must come to terms on how to split the difference. If the buyer doesn’t have the cash to make up the difference, the deal could be off. 8
How long does underwriting take?
It actually varies from one loan application to the next, because every borrower is different. The loan type can also affect the length of the process. Some people “sail through” the process with no issues,while other borrowers hit a lot of snags along the way.
In general: Mortgage underwriting can take anywhere from a few days to a few weeks. Five to eight business days is probably a good average (from the time the underwriter receives the file, up until a final determination is made).
How long it takes often comes down to two things: (1) the efficiency and workload of the underwriter, and (2) the number of issues or conditions that arise during the process.
A huge factor in the timing is the green light, yellow light, red light scenarios mentioned above. Getting a green light generally means you’re sailing through, whereas a “yellow light” or conditional approval might slow things down. This depends how quickly the borrower can provide the necessary docs to the underwriter, and how long it takes the underwriter to clear the conditions.
As a borrower, the best thing you can do during this process is to stay in touch with your loan officer, and to resolve any conditions that arise as fast as possible. This will prevent or minimize delays. 9
Why is underwriting so strict now?
Basically, the lenders are trying to avoid another mid-2000’s incident and the crash that followed. Underwriting standards were much looser then than they are now. Many people were approved for loans that they couldn’t really afford, thus leading to the housing crisis. Lenders want to make sure that they’re loaning on the value of the property, which is why appraisals have tighten their belts as well.
RECAP- super short and sweet
Underwriting: the process of getting approved for a mortgage.
Underwriter: the entity that verifies your capacity, credit and collateral. They also review the appraisal.
How long does it take: Anywhere from 5 days to a few weeks. This depends on how busy the lender is, how fast the borrower can provide necessary documents, and how complicated the borrower’s finances are.
Why did I bother getting preapproved? Although a preapproval is thorough, the underwriter has to make sure nothing changes with your credit and capacity. They also review the appraisal to make sure the value of the loan matches the value of the home.
Why so strict: To avoid mid-late 2000’s housing crisis