If you are looking to get approved for a home loan, you may be vaguely familiar with what it takes to pass the underwriting process and get approved. Most people only get a home loan every few years at the most so it is understandable that the average person doesn’t know the fundamentals of getting approved for a home loan.
In this article, we are going to cover the essentials of being worthy of a home loan approval. Whether you are thinking of buying that first home, refinancing your current mortgage or investing in Real Estate, these fundamentals apply equally.
The Three “C’s — Credit, Capacity, Collateral
Practically everyone in the mortgage business who works on the processing and underwriting departments are aware of the three “C”s of qualifying. We are going to share that with you so you have sort of an insider’s perspective on this concept.
Every loan applicant is evaluated by looking at these three areas of their borrower profile:
Let’s dive in and get more details on each area.
Credit is one of the first things underwriters look at when evaluating an application. A borrower needs to have sufficient credit, in other words, enough trade lines open with a payment history to evaluate their credit history. The credit profile demonstrates the applicant’s capacity AND willingness to pay their bills on time.
Those of us in the business see it often, applicants with great income but poor credit. They have the capacity but lack the willingness. They often cry foul that they are being harshly judged, after all, they make enough money to pay it all. That means very little in underwriting, you have to pay your bills on time or you don’t get a loan, period.
A borrower’s credit needs to meet some very specific criteria to qualify. A credit score is not the end-all to qualifying. In addition to meeting the minimum credit score standards, the borrower has to have enough open trade lines, and a mix of types of credit. The underwriter needs to see some revolving credit as well as some installment debt. So you better have some credit cards and a loan, such as a car loan.
Capacity is the ability and financial resources to meet obligations, past and future based on the new loan the borrower is applying for.
Capacity mostly revolves around income and assets. The borrower needs to have sufficient stable income to pay for all the obligations they would have, including the loan they are applying for.
This is where underwriters calculate the “Debt To Income” ratio (DTI). Every loan program has its own DTI requirements and in order to qualify for the loan those need to be met. It is not sufficient that you have the income; you have to document that you have it. Sometimes, this is a bit of a battle with self-employed people in certain businesses.
People who get a substantial part of their income paid in cash often don’t realize they have to keep meticulous accounting of this for at least 2 years to get a loan.
Income is usually verified with income taxes, paystubs and the employer’s W2 forms. This is the documentation part. They all have to be congruent as well. Income analysis is one of the most tedious and painstaking parts of underwriting a loan. Unfortunately, many applicants attempt to commit fraud. Underwriters have to look at every detail of paystubs, W2s, tax returns, and anything else they can avail themselves of to make 100% certain that the borrower actually makes the money they represent to make.
There are loan programs that you can apply for and get approved for without income. This is possible by demonstrating the capacity to meet financial obligations with verified assets they own. If you have a couple million in the bank and are asking for a $500,000 mortgage to buy a house, there is a relatively good level of confidence the borrower is not going to lose the house because they can’t pay. They have the resources and, based on their credit profile, they need to also show a willingness to pay.
Last but not least is the collateral analysis. The real estate property being pledged as collateral for that mortgage needs to pass muster.
Every loan program has its criteria required for getting a loan against real estate. Let’s look at the most common loan types and their collateral requirement basics.
Conventional and Government Financing
Loans issued by Fannie Mae and Freddie Mac are the most common loan types, followed by FHA and VA financing Their basic requirements of the property are the three “S”s:
The property must provide a safe and healthy environment. This takes into account location many times. Properties located close to any hazards such as chemical plants, rivers that could flood, etc., are scrutinized a great deal. Fortunately, the majority of the time, loans are for regular homes that anyone would feel safe living in.
The property needs to be free of structural defects. This part is a bit tricky sometimes when people are looking to remodel a house and maybe stopped half ways because they ran out of money and now need a loan to finish. If they already tore up the floors, removed part of the roof, and excavated the front yard, they won’t get a conventional loan in most cases. There are, however other types of loans available.
The home should offer the occupants protection. Walls must be in good structural condition, the roof in place, and doors and windows functional for their purpose.
These are the most fundamental elements at a high-level overview of property requirements. Underwriting guidelines are actually quite specific and number dozens of pages related to property requirements. If your property meets the above, you have a good chance at getting a loan.
So there we have it, a simple overview of what it takes to qualify for a mortgage. If you have all the above criteria, you are ready to call a lender and start talking specifics about home financing rates and terms.