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The 4 C’s of Mortgage Underwriting
From Keeping Current Matters, on April 5, 2012
With the spring market upon us and new buyers out looking for houses, I thought it might be a good time to review the basics of what lenders look for as they decide to approve (or deny) mortgage applications. They’re called "The 4 C’s of Underwriting”- Capacity, Credit, Cash, and Collateral. Guidelines and risk tolerances change, but the core criteria do not.
CAPACITY
CAPACITY is the analysis of comparing a borrower’s income to their proposed debt. It considers the borrower’s ability to repay the mortgage. Lenders look at two calculations (we call ratios). The first is your Housing Ratio. It simply is the percentage of your proposed total mortgage payment (principal & interest, real estate taxes, homeowner’s insurance and, if applicable, flood insurance and mortgage insurance – like PMI or the FHA MIP) divided by your monthly, pre-tax income. A solid Housing Ratio (often called the front end ratio) would be 28% or less; although, at times loans are approved at a significantly higher number. That’s because your front end ratio is looked at in conjunction with your back end ratio.
The back end ratio (referred to as your Debt Ratio) starts with that mortgage payment calculation from the Housing Ratio and adds to it your recurring debts that would show up on your credit report (auto loans, student loans, minimum credit card payments, etc.) without taking into consideration some other debts (phone bills, utility bills, cable TV). A good back ratio would be 40% or less. However, loans sometimes are granted with higher debt ratios. Understand that every application is different. Income can be impacted by overtime, night differential, bonuses, job history, unreimbursed expenses, commission, as well as other factors. Similarly, how your debts are considered can vary. Consult an experienced loan officer to determine how the underwriter will calculate your numbers.
CREDIT
CREDIT is the statistical prediction of a borrower’s future payment likelihood. By reviewing the past factors (payment history, total debt compared to total available debt, the types of monies: revolving credit vs. installment debt outstanding) a credit score is assigned each borrower which reflects the anticipated repayment. The higher your score, the lower the risk to the lender which usually results in better loan terms for the borrower. Your loan officer will look to run your credit early on to see what challenges may (or may not) present themselves.
CASH
CASH is a review of your asset picture after you close. There are really two components – cash in the deal and cash in reserves. Simply put, the bigger your down payment (the more of your own money at risk) the stronger the loan application. At the same time, the more money you have in reserve after closing the less likely you are to default. Two borrowers with the same profile as far as income ratios and credit scores have different risk levels if one has $50,000 in the bank after closing and the other has $50. There is logic here. The source of your assets will be examined. Is it savings? Was it a gift? Was it a one-time settlement/lottery victory/bonus? Discuss how much money you have and its origins with your loan officer.
COLLATERAL
COLLATERAL refers to the appraisal of your home. It considers many factors – sales of comparable homes, location of the home, size of the home, condition of the home, cost to rebuild the home, and even rental income options. Understand the lender does not want to foreclose (they aren’t in the real estate business), but they do need to have something to secure the loan against, in case of default. In today’s market, appraisers tend to be conservative in their evaluations. Appraisals are really the only one of the 4 C’s that can’t be determined ahead of time in most cases.
Now, each of the 4 C’s are important, but it’s really the combination of them that is key. Strong income ratios and a large down payment with strong reserves can offset some credit issues. Similarly, long and strong credit histories help higher ratios….and good credit and income can overcome lesser down payments. Talk openly and freely with your loan officer. They are on your side, advocating for you and looking to structure your file as favorably as possible.
The Economic Big Picture
It’s been awhile since I’ve posted…to be honest, I’ve been busy selling houses! However, with all the chaos going on with regard to the economy, I felt compelled to do a little research.
Take a look at the data below and draw your own conclusions…is the sky falling?
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Measure
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August 2010
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August 2011
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Dow Jones
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10,213.62
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11,405.93
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S&P 500
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1,071.69
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1,192.76
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NASDAQ
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2,179.76
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2,523.45
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30 Year Mortgage
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4.44%
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4.32%
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National Unemployment
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9.7%
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9.2%
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Table from KCM Blog Post, August 17, 2011
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Only you know if it's the right time to buy or sell your home. With interest rates low (I have clients who locked in this week at 3.87% for a conventional 30 year fixed!) and prices continuing to drift downwards, this remains one of the best times in history to purchase a home.
I’ve had a spectacular year in real estate to date. I don’t want to appear to be bragging, but it’s important to show that the real estate market is still moving! I’ve closed 34 sales in the last 12months. There are lots of other Realtors who will report the same.
If you’re thinking this might be the right time to make a move, please give me a call or shoot me an email. It’s still a difficult market and you need a Realtor with both experience and the skills to help you make it happen. I'd like to help you love where you live!
Kristin
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