Real Estate Underwriting Process

Learning Objectives

• Students should be able to describe the basic steps in the underwriting process.
• Understand the goal of underwriting (qualifying) standards.
• Define different classifications in an automated underwriting report.
• Discuss an underwriter's considerations: credit reputation, income, and net worth.
• Define quantity, quality, and durability of income.
• List types of income that qualify as stable monthly income.
• Explain how to use income ratios to measure income adequacy.
• Calculate net worth using assets and liabilities.
• Understand credit history and credit scores.
• Explain other underwriting considerations, such as LTV, repayment period, and property type.

Suggested Lesson Plan

• Students should review the previous chapter, "The Financing Process," using Exercise 8.1.
• Provide an overview of Chapter 8, "Qualifying the Buyer," and review the learning objectives for the chapter.

The Underwriting Process

• The process of evaluating a proposed loan to ensure the buyer and property meet the lender's minimum standards.
• Qualifying standards are used to identify acceptable and unacceptable loan risks with secondary market considerations from Fannie Mae, Freddie Mac, FHA, or VA.
• Automation is used to analyze loan applications based on the performance of millions of existing mortgages to identify which factors increase or decrease the likelihood of default.
• Applications are classified as "Accept" to approve, or "Refer" for further review by an underwriter.
• The report also indicates the documentation required for further scrutiny or if an on-site appraisal isn't needed.
• Automated underwriting reports categorize risk, document required, and property appraisal needs.
• There are three main categories in underwriting recommendations: risk, documentation, and appraisal.
• Loan type affects risk assessment (e.g., an ARM is riskier than a fixed-rate loan).
• Owner-occupancy vs. Investor status: higher risk associated with an investor loan.
• Property type: certain properties may present higher risk due to factors like appreciation rate.

Evaluating Creditworthiness

• Creditworthiness is evaluated based on credit reputation, income, and net worth.
• Creditworthiness can be offset by strength in other factors.
• Credit reports: contain loans, purchases, and payment history for the past 7 years.
• Credit history refers to the length of time an individual has borrowed and repaid money.
• Credit scores: predict default risk based on past credit history, often based on FICO score.
• Major derogatory incidents (charge-offs, collections, repossessions, foreclosures, and bankruptcies) influence creditworthiness negatively.
• Credit reports may include information from three major credit reporting agencies: Equifax, Experian, and TransUnion.

Income Analysis

• Income is evaluated for quantity, quality (dependability), and durability (likelihood of continuation).
• Stable monthly income: income meeting quality and durability tests.
• Income sources: self-employment income, commissions, overtime, bonuses, retirement income (pension/social security), alimony/child support are generally considered dependable; temporary employment, unemployment benefits, and income from family members without obligation are not.
• Income ratios: measure the proposed monthly mortgage payment and installment debt against pre-tax income.
• Housing expense ratio: measures proposed monthly mortgage payment against pre-tax income.
• Child support, if paid consistently is accounted for in determining income.
• Non-taxable income may be "grossed up" because it is assumed the income will be taxed, increasing the likelihood of payment.

Net Worth

• Funds required to cover down payment, closing costs, and other related expenses.
• Liquidity is necessary after down payment, for up to 3 months' worth of monthly expenses.
• Assets: include funds for closing, savings accounts, retirement accounts, and other property such as automobiles, furniture, and real estate.
• Liabilities: include debts like credit cards, student loans, car loans, unpaid taxes.
• Gift funds can be used, if given and not obligated to be repaid.
• Delayed financing: financing may be obtained after closing.
• Net equity refers to the difference between the market value of a property and the total liens against the property.