I. Introduction
The following guide has been prepared as a comprehensive manual to outline the process of evaluating mortgage applications. Knowing more about what goes into processing and underwriting loan applications will allow you to better complete a loan application and be better prepared for the steps ahead in obtaining a loan approval and seeing the loan to funding.

Understanding the process of evaluating a mortgage application from the underwriter’s point of view will prove to be very helpful for every party involved. Included in the following guide is a detail of the responsibilities mortgage lenders including: a careful review of credit history, debts, income, information about the property in question, and other factors that will be explained. The lender’s main objective is to obtain the best loan approval possible for any one particular borrower.

II. Factors Considered During the Approval Process
The factors that go into an approval process include information regarding the amount of money invested in a home, the financial situation of the borrower (including debt and income), the reason for the loan, the desired type and length of the loan, the property type, and the number of individuals applying for the loan.

A. Equity and Loan-to-Value Ratios
The equity is the financial interest an applicant has in the home. It is the amount of the down payment, or if refinancing, it is the difference between the fair market value of the home and the amount still owed on the mortgage. The loan-to-value ratio is a calculation of the amount of the mortgage as a percent of the value of the home. For example, if the purchase price of a home is $100,000 and the mortgage is $90,000, the equity is $10,000 and the loan-to-value ratio is 90 percent.

A borrower who makes a large down payment or who has a lot of equity in his or her home is less likely to default on a loan than a borrower who makes a small down payment and has a small amount of equity in a home. In other words, the more equity, the lower the risk associated with the mortgage loan. A low loan-to-value ratio may offset other risks that are identified in a loan application.

Over time, as payments are made toward a mortgage, the loan balance decreases and equity increases. Combined with maintaining and improving the condition of the home, the equity in your home will increase and the Loan to Value will decrease.

B. Liquid Reserves
Liquid reserves are the funds left, after a down payment is made, when purchasing a home. Some examples of liquid reserves include funds in a checking or savings account; the net value of stocks, bonds, and mutual funds; the vested portion of 401(k) accounts; and funds in IRA or Keogh retirement accounts. Higher amounts of liquid reserves are looked upon more favorably than lower amounts or no reserves. Mortgages to borrowers with higher amounts of liquid reserves are a lower risk so saving money and increasing liquid reserves over time will help in the approval process when applying for mortgages.

C. Debt-to-Income Ratios
One way underwriters determine how much debt a borrower can handle is to calculate the debt-to-income ratio. This involves measuring how much is owed (debt) against how much is earned (income) on a monthly basis. The debt-to-income ratio is calculated by dividing total monthly debt (including mortgage loan payments, monthly installment payments, and minimum payments on all revolving debt) for all borrowers by the total gross monthly income of all borrowers.

• For example: $2,000 monthly debt (including new mortgage loan payment) ÷ $6,000 gross monthly income = .33 (33%) debt-to-income ratio.

When determining mortgage loan payments, be sure to include principal, interest, real estate taxes, hazard insurance, and mortgage insurance (if required). Generally, the lower the debt-to-income ratio, the better the financial condition of the borrower. As the ratio increases, the level of risk also tends to increase. Knowing how to calculate the debt-to-income ratio is important because it helps indicate whether a borrower will be able to afford a mortgage payment in addition to other financial obligations. Most importantly, it helps a lender determine the future financial implications of approving the loan.

Alimony, child support, bonuses, commissions, tips, dividends, interest earnings, government benefits, and more can be used when documenting income. Documenting income from sources other than W-2’s often requires more detailed paperwork but these funds are still a common form of income used when applying for mortgage loans (history and continuance may need to be established). Often tax returns will be used and the borrower’s employer may be contacted to provide additional income information.

Total recurring debt responsibilities will include mortgage payments, rent, car payments, installment loans, student loans, alimony, child support, 401(k) loans, co-signed loans, and minimum payments on credit card debt.

D. Loan Purposes
The loan purpose is the reason you are applying for a mortgage loan. It may be to purchase a home or you may want to refinance an existing mortgage--either to obtain a lower interest rate or to get cash--if you have sufficient equity in your home. There is a certain level of risk associated with each reason for the loan, whether for purchase or refinance. In general, buying a home represents less of a risk than refinancing an existing mortgage. Refinance transactions in which the borrower takes out little or no equity (cash) represents less risk than those transactions in which the borrower takes out a lot of cash. Withdrawing a large amount of cash from the equity in the property may require written explanation to the underwriter.

E. Loan Types
Borrowers may choose a fixed-rate, an adjustable-rate, or a balloon mortgage. A fixed-rate mortgage is one in which the interest rate remains the same for as long as the borrower holds the loan. If the borrower plans to live in the home for many years, a fixed interest rate will usually be a priority. An adjustable-rate mortgage (ARM) has an interest rate that can change up or down as market conditions change. An ARM often starts out with a lower interest rate for a certain period of time, after which mortgage payments may change periodically (for example, once or twice a year). Interest rate changes typically are subject to two caps (limits), one for each adjustment period and one for the life of the loan. For example, a typical ARM that adjusts annually may have a per adjustment period cap of 2 percentage points and a lifetime cap of 6 percentage points. If the borrower is confident that their income will increase steadily, or if the borrower plans to move and isn’t concerned about potential rate increases, they may want to consider an adjustable-rate mortgage. If the loan has a streamline refinance option, it is usually a very attractive option. This will allow the borrower to refinance their loan without the traditional costs of standard refinance. Balloon mortgages typically offer lower interest rates for shorter-term financing, usually five to seven years. At the end of this term, the borrower has the option to refinance the mortgage for the remaining term or pay off the outstanding balance with a lump-sum payment. If the borrower anticipates selling or refinancing within the specified number of years, a balloon mortgage may be the ideal loan. If the borrower is considering a balloon or adjustable mortgage, they should look at all the factors and conditions pertaining to the terms of the loan and the possibilities connected with refinancing or paying the loan off during the amortization period. Finally, there are often other unique products that allow for a combination of the above loan types that may allow a lower rate with other possibilities during the loan term that may be of interest and can be discussed with a loan advisor.

Balloon mortgages, and adjustable-rate mortgages that change interest rates once a year or more, tend to be higher risk for default than mortgages with longer fixed payment periods but often are more affordable than fixed rate loans for the customer.

F. Loan Terms
The loan term is referred to as the amortization period is defines the length of time it will take to pay off a mortgage. The loan term is expressed as a number of months. For example, for a 30-year fixed-rate mortgage, the term is 360 months. The standard loan term is 30 years. However, shorter terms are available that enable a borrower to build equity in the home faster. Borrowers who choose to finance their mortgages over shorter terms and build up equity in their homes faster tend to perform better than mortgages with longer terms.

If a borrower decides to choose a mortgage with a shorter term, such as a 15-year amortization, it may be considered a higher risk loan because the payments are higher. However, loans with shorter terms will most often save a borrower thousands of dollars in interest as compared to a longer-term loan.

G. Property Types
Property type refers to the type of home for which you have requested a mortgage loan. These might include:
• One-unit residential properties
• Two-unit properties/duplex
• Three-unit properties/triplex
• Four-unit properties/fourplex
• Condominiums or Cooperatives
• Five (or more) unit properties do not fall into conforming guidelines and generally become commercial loans as opposed to obtaining a residential mortgage.

The type of property securing a mortgage will often have an impact on the overall risk and performance of a mortgage. For example, a one-unit residential property is usually the lowest risk, while three- and four-unit residential properties are a higher-risk (because of the outstanding market conditions, upkeep and maintenance factors that play on rental properties).

H. Number of Borrowers legally responsible for repayment of the mortgage loan
For each mortgage loan, there must be at least one borrower. The presence of more than one borrower on a mortgage application generally helps to reduce risk. This is due to the fact that mortgages with more than one borrower tend to have a lower default rate than mortgages with only one borrower.

Additional borrowers will not necessarily reduce the level of risk on a loan. Each borrower will be analyzed for credit and income purposes. Adding more than the standard one to two borrowers to an application may help when the sole borrower(s) do not have enough income or credit to obtain the mortgage on their own.

I. Self-Employed Borrowers
A self-employed borrower, who is either the owner or part owner of a business, has control over the income that is earned from the business. The business may be a sole proprietorship, a partnership (general or limited), or a corporation. Because of the increased chance of uneven cash flows, self-employment introduces an additional layer of risk to a mortgage loan application that is not present with salaried borrowers. This additional risk is generally considered adverse only when a self-employed borrower has other high-risk factors associated with his or her loan, such as a history of delinquent payments or a low level of savings. A self-employed borrower showing good credit history and a sound income history on tax returns can be just as qualified as any other borrower.

Self-employed borrowers tend to default on mortgages more often than salaried borrowers (all other things being equal). High levels of liquid reserves are the easiest way to improve the loan credit profile.

J. Credit Factors
1. One of the first steps a lender completes when analyzing an application for a mortgage is to review the borrower’s credit report. A credit report shows debts and payment history with creditors who have loaned the borrower money, such as credit card companies, banks, and department stores. It indicates whether bills are paid on time and whether they were paid the proper amounts due. It also reveals how much debt is currently outstanding and whether loans have been paid back when due. Credit reports also document a history of tax liens, bankruptcies, and other public records for up to 10 years. The credit report will also specify the names of those have authorized to obtain a copy of your credit report and will indicate how often a borrower may have applied for credit over the past two years. This data is kept on file electronically by three private credit bureaus: Equifax, Experian, and Trans Union.

If a borrower would like to obtain and review a copy of their credit report they can contact the credit bureaus directly. It is important that the borrower’s credit report be an accurate reflection of their credit record. If the borrower discovers any mistakes or problems with their credit report they should contact the appropriate credit bureau to initiate an investigation. A list of the bureaus and their corresponding telephone and address information is found below.

Automated underwriting uses the information contained in your credit report as part of the underwriting process. The credit report factors include: credit history; delinquent accounts; credit card accounts; public records, foreclosures, and collection accounts; and inquiries. It weighs each characteristic based on the amount of risk and its significance to the underwriting recommendation. Underwriting assesses credit behavior over a period of time. Therefore, short-term attempts to improve a credit record, such as paying off an account or closing an account, may not always have a positive impact on your credit record. Long-term attempts to improve credit on the other hand are most often beneficial.

2. Analyzing a credit report
Credit history is an account of how well a borrower handles credit, both now and in the past. Generally, the longer the credit history, the better. An older, established account--even one with a zero balance--may have a more positive impact on a credit record than a newly established account. Having a relatively new credit history (a few recently opened accounts) is not automatically considered a higher credit risk. Making payments as agreed on newly established accounts signifies less risk than not making payments as agreed on older accounts. If a borrower does not have any established credit history (the type of credit that is typically reported to a credit bureau) it does not mean the borrower will be unable to get a mortgage. Although an automated underwriting system does not evaluate credit information that is not reported to a credit bureau, a traditional underwriter may be able to work with payment history regarding such items as rent and utilities to establish a "nontraditional" credit history.

All of your established accounts, whether active or inactive, are considered in evaluating your credit history. A borrower should think twice before closing established inactive accounts or opening a lot of new accounts. Either of these actions may have a negative impact on credit history.

3. Delinquent Accounts
Credit reports contain information on credit accounts where regular payments are made. This includes everything from car loans to credit card bills. A payment history that shows paid 30 days late or longer can have a negative impact on credit. When applying for a mortgage loan, even more significant is a history of being late on current or past mortgage loan payments. Many borrowers believe that if a late payment is brought current; their credit report will not reflect their previous payment delinquency. This is not the case. Underwriters review overall payment history when evaluating loan applications. The amount of time that has elapsed since an account was delinquent is another important factor included in the evaluation of your payment history. The more recent a delinquency, the higher the risk. For example, a 30-day late payment that is less than three months old indicates a higher risk than a 30-day late payment that occurred several years ago.

4. Credit Card Accounts
Credit cards are tools that can be used to establish good credit. Credit cards can show that a borrower knows how to manage credit wisely, either by paying off the balances every month or by keeping them very low. It is also possible to get into debt trouble by overusing or misusing credit cards. There are two types of credit card accounts—revolving credit card accounts and 30-day accounts. A revolving credit card account does not require immediate repayment of the credit charge. Instead, the customer is only responsible for a minimum monthly payment—usually a small percentage of the balance. A 30-day account is one that requires payment of the full balance within 30 days. The amount of credit a borrower has and how it is used is very important. When all of the available credit is used, there is a high likelihood the borrower is overextended. Therefore, when the total amount of debt owed on all of open credit card accounts is close to the credit limit, this indicates higher risk.
Some signs that a borrower may be carrying too much debt:
• Do you have balances that never seem to drop?
• Are your balances getting higher?
• Do you regularly make low or minimum payments?
• Do you juggle bill payments?

5. Public Records, Foreclosures, and Collection Accounts
If debts are not paid for a prolonged period of time, certain legal actions may be taken that will appear on the credit report. Legal actions such as bankruptcies, judgments, and tax liens are public records included on credit reports.
• A bankruptcy is a proceeding in a federal court in which a person who owes more than he or she can afford to pay seeks relief from paying their debts. The result of the proceeding may be the establishment of a court-approved repayment plan or the liquidation of the person’s assets.
• A judgment is the decision made by a court of law that states that another person or creditor is owed money.
• A lien is a legal claim against a property that must be paid off when the property is sold. One example is if taxes are not paid, the taxing authority can file a claim against assets, including a home. This is a tax lien. A foreclosure also will be indicated in the credit report. This is a legal procedure by which a borrower who is unable to pay his or her mortgage loses their home. This usually involves a forced sale of the property at public auction with the proceeds of the sale applied to the mortgage debt. Sometimes, a borrower will voluntarily give a deed to the creditor to satisfy the debt and avoid foreclosure. This is referred to as a deed-in-lieu of foreclosure. Collection accounts also will be contained in the credit report. These are any unpaid bills or obligations that have been reported to a collection agency. A credit record that contains bankruptcies, judgments, liens, foreclosures, or collection accounts indicates higher risk. The more recent these incidents, the more negative the impact on your credit profile.

Reestablishing credit and maintaining a good payment history are very important after a bankruptcy or foreclosure. Although most public record and foreclosure information is retained in your credit report for seven years (ten years for bankruptcies), as time passes, it becomes less significant to the underwriting process.

6. Credit Scores
A credit score is a score determined by the credit reporting agencies that shows an underwriter how a borrower ranks when compared to other borrowers. Scores usually range from the 500’s to the 800’s. Most borrowers with relatively good to great credit fall into the 650 to 750 range. While automated underwriting does not take into account the specific score given by the credit reporting agency in determining approval, a credit score will usually be indicative of what kind of loan the borrower may qualify for. In general, borrowers with higher scores qualify for more loan options but there are usually loan programs available for almost any borrower assuming the other factors that determine approval fall into line as well (i.e. LTV, income, etc.).

III. Underwriting
Underwriting is the process used to make mortgage loan decisions. During underwriting, a Loan advisor/Processor/Underwriter may decide to use an Automated Underwriting system to underwrite a loan. Automated Underwriting uses an electronic (computer-based) underwriting system that helps mortgage lenders/bankers collect and analyze the information needed to evaluate mortgage loans. The following information provides an easy-to-follow overview of the factors Automated Underwriting considers when evaluating a mortgage loan application.

Automated Underwriting makes recommendations based on the following risk factors:
1. Credit Reporting
• Credit history
• Delinquent accounts
• Credit card accounts
• Public records, foreclosures, and collection accounts
• Inquiries

None of these factors alone determines an Underwritten recommendation. All of the risk factors are evaluated together to help reach a decision about a loan application. When Automated Underwriting determines that a loan application does not appear to meet its credit risk criteria, it refers the loan to a traditional underwriter (human) for further review and provides suggestions about where additional information could be helpful.

2. Other Non-Credit Report Factors
• Equity and loan-to-value ratio
• Liquid reserves
• Debt-to-income ratio
• Loan purpose
• Loan type
• Loan term
• Property type
• Number of borrowers
• Self-employed borrowers

Automated underwriting recommendations are taken into consideration by the loan advisor, but are not the definitive element in the final decision. The final decision to approve or deny a mortgage loan application are made by a human underwriter and according to the specific loan guidelines that a loan has been submitted under.

3. Underwriting Rules
• The same criteria is applied to every loan application. This consistency and objectivity results in a fair and unbiased underwriting recommendation. Automated Underwriting does not consider factors such as age, race, religion, gender, national origin, or marital status in making a recommendation.
• Credit report and non-credit report factors are both evaluated. No single factor is the sole basis for a recommendation. This information is weighed based on the amount of risk and overall significance to the underwriting recommendation. All information is considered in a way that recognizes that a borrower’s strengths in one area can offset risk factors in another area.
• Through automated underwriting less paperwork is required, evaluations are delivered quickly, thoroughly, and are unbiased.
• Data is analyzed from the credit report to determine how credit is managed. Credit scores are not always the only criteria used in an analysis of a borrower’s creditworthiness.
• Evaluations and determinations of risk are based on the past performance of other loans to similar borrowers and are continually fine-tuned based on new data and loan performance.

IV. Conclusion
A basic understanding of the process of evaluating mortgage applications will provide you with a more enjoyable mortgage experience—not just at origination of the loan but over the life of the loan a borrower will rest assured knowing they closed the right loan for them.

If you have additional questions, or are ready to apply for a mortgage loan, Loan Advisors are always available and will be able to provide you with the most up to date technology and information currently available.