Basic understanding of Real Estate Loan Underwriting Guidelines

So you can have a basic understanding of underwriting, I will describe some of the underwriting guidelines lenders use in determining approval of a real estate loan.

This will also assist you in understanding what type of supporting documentation may be required for a particular loan program that you selected for your financial needs.

The entire underwriting guidelines of a lender are not going to be included because they consist of hundreds of pages, and each lender, lenders program have different types of underwriter guidelines. The following guidelines are simply that, basic underwriting guidelines, but will also show you some of the more typical standard guidelines used in the lending industry.

EVALUATING THE BORROWER:

CREDIT HISTORY

All loan packages must include a current standard factual data credit report (generated by the lender) and a loan verification of current mortgages dated within 90 days of submission to the lender. The credit report must be from an acceptable independent credit agency, and show borrower's employment status, credit references and legal matters. Debt items on the credit report and the loan application should correspond.

For any deficiencies in the borrowers debt repayment history, satisfactory documentation must be provided stating cause(s) of the credit problem(s) and corrective action(s) taken. Any significant debts not disclosed in the loan application (but listed in the credit report) should also be satisfactorily explained and documented.

A borrower with a record of late payments or other credit deficiencies may not be eligible for financing. A borrower who has defaulted on a previous mortgage or has filed bankruptcy is not eligible for financing (Conventional financing).

(A person can show that he or she has re-established credit with new credit accounts or loans, obtained since the problem, which were "paid as agreed").

A lender must feel not only that an applicant is able to make payments, but also that he or she wants to pay. This will be decided according to how the applicant paid bills in the past. A credit report will be checked for an established pattern, or habit of making payments on time. One or two discrepancies within an overall good pattern will probably be ignored. Previous home payments will be looked at most carefully. (Even a bankruptcy may not be hopeless. Some lenders will consider these cases if: 1) some time has passed ((typically two to three years since the discharge of the bankruptcy)), and (2) good credit has been firmly re-established ((as explained above)). If simple carelessness or poor financial management led to the bankruptcy, a lender will be relatively tough about a waiting period and re-establishment of credit. However, if the cause was something over which the applicant had little control, lenders will be easier).

EMPLOYMENT AND INCOME

The amount of the borrower's income which may qualify for financing purposes depends upon many factors: The borrower's occupation, employment stability, opportunities for future advancement and educational background; The source and stability of certain types of non-salary income; and the adequacy of verification.

A minimum of two full years of employment preceding the mortgage application should be verified. Each verification of employment (VOE) should be signed by both borrower and the employer. Any employment gaps or problems noted by an employer should be explained in writing by the borrower.

If the borrower has an employment history of less than two years and was previously in school or the military, a copy of a diploma, transcript, or discharge papers should be provided to satisfy questions regarding continuity of employment. When a borrower is employed by a relative or closely held business, or when he or she is a commissioned employee, copies of complete signed tax returns for the most recent two-year period is required.

A favorable risk rating generally is given to a borrower who has demonstrated job stability in some lines of work. Job changes are recognized as normal. Frequent and successful job changing because a borrower has outgrown the job opportunities of the previous employer is also an indicator of favorable employment continuance. On the other hand, a record of unemployment or excess job-hopping without advancement may raise concerns about future employment and income stability. In such cases, offsetting financial strengths may be necessary to qualify a borrower for maximum financing.

Commissions, part time income, overtime, and bonuses must be verified by the employer for a minimum of two years, and should be expected to continue. If income from those sources exceeds 25% of qualifying income, signed copies of complete tax returns and w-2 forms for the most recent two years filed, (1099 forms if on commissions only) plus current pay stubs, are required. Since the income may be subject to fluctuation from year to year, the amount, which may be used to qualify a borrower, is developed from the average of the most recent two-year earnings. (Some lenders will average the last three years if the borrower is strictly on commissions). The earning trend is also considered: Annual earnings that are increased are favored; a declining earnings trend may raise concern about future continuance and stability. Child support/alimony income should be expected to continue for at least three years after the date of the mortgage application. A photo-copy of the divorce decree or separation agreement should be included, specifying the amount of the award and the period of time over which it will be received. Verification that the funds have been received for the last twelve months must also be provided. Acceptable evidence includes deposit slips, canceled checks, court records, or tax returns.

Dividends, interest and other investment income can be used to qualify if properly documented, received for the last two years and expect to continue. Photocopies of signed tax returns and account statements from banks, brokers, etc., may be used to verify this income and the underlying income producing assets.

For all investment property, rental income must be documented with a lease agreement, signed copies of complete tax returns for the most recent two years filed, and, where available, an operating income statement (E.G. FNMA form 216 or equivalent). Qualifying income from investment property is determined by deducting from gross rental income an allowance (not less than 25%) for vacancy, rental commission, management fees and other expenses (unless vacancy can show for a two year period, zero vacancy, no management fees, etc. than the 25% factor may be waived). Monthly debt service, principal, interest, taxes, insurance and any condominium fees should be subtracted from qualifying income. If the resulting cash flow is positive, it is included as income; if negative, it is included in obligations.

The self-employed borrower must provide signed copies of tax returns filed for the most recent two-year period. Copies of canceled checks for tax payments and a certification from the preparer of the tax returns may also be required. (For loan to value in excess of 80%). If an individual has filed an extension request for the most recent tax year, a copy of the extension request and copies of related canceled checks submitted to the Internal Revenue Service should be provided.

When the self employed borrower has a 25% or greater ownership interest in a business, the lender may require the following: signed copies of partnership/corporation income tax returns for the most recent two years filed with all applicable schedules attached; a business credit report and current financial statements (audited if possible), including internal financing statements if more than four months have elapsed since the end of the last fiscal year. (If the loan to value is less than 80%, the above may not be required).

CASH RESERVES

The borrower's cash reserve must be no less than the total of the down payment, settlement costs and two monthly mortgage payments.

DOWN PAYMENT

The minimum cash down payment from the borrowers own assets must equal at least 5% of the purchase price. Gift letter may be for the total down payment (differs from lender to lender), but borrower must have cash reserves of at least two monthly mortgage payments. A copy of an acceptable verification of deposit (Such as: FNMA form 1006) must be submitted. Satisfactory explanation should be provided where there are indications that the down payment was provided through the use of borrowed funds-such as a recently opened account, a recently received large deposit, or an account balance substantially greater than the average balance for the two months preceding the date of the verification of deposit form.

GIFT LETTER

Gifts for part or all the down payment are acceptable if the donor is an immediate family member of the borrower, or can show evidence that the donor will become an immediate family member within a reasonable time frame. The gift must be evidenced by a letter that is signed by the donor, specifying the dollar amount of the gift, the date the funds were transmitted, and the donor's name, address, and relationship to the borrower(s). The donor must include a statement that no repayment of the gift is expected. A notarized affidavit may be required. The donor must verify with the gift letter that funds are available that equal the amount stated on the gift letter. This verification may be in the form of the following: Automatic Teller Machine receipt dated the same date as the gift letter that shows the donor has funds available equal to the amount stated in the gift letter. A letter from a recognized bank that indicates funds are available by the donor that equal the amount stated in the gift letter, signed by a bank officer.

DEBT RATIOS

Monthly housing expenses include Principal, Interest, Taxes, Insurance, and any Home Owners Associations fees, if applicable.

To obtain financing necessary to purchase a home, a buyer must meet requirements in four areas: Income, stability of income, assets, and credit. These requirements will vary somewhat from lender to lender. A weakness in one area can sometimes be overcome by strengths in another area.

The borrower's total monthly debt payments include housing expenses, installment debts with more than 10 remaining payments, alimony, child support or maintenance, and any negative cash flow from rental properties. Payments on revolving debts are normally considered a continuous obligation, and at least 5% of the outstanding balance of each debt should be included in debt ratios.

There are many other areas an underwriter must consider when reviewing a loan package such as: Non-occupant co-mortgagors (co-signers) how is their credit (who are they), their income, debt ratio´s (all of this has to be viewed the same way as if they were the borrower), if the borrower is a resident alien (if not, what forms and information is required), and of course, the Appraisal itself (is the value of the property adequate for the loan to value ratio in a purchase or refinance). I will not get into all the specifics of the above, but I only want to make you aware of them.