Underwriting is often the most dreaded part of the mortgage process. Potential borrowers see the underwriters as people out to get them and refuse their loan approval. Luckily, this is not the case. The underwriter’s job is to protect the lender from default. They have strict guidelines to follow to ensure borrowers can afford the loan. The most common mortgage underwriting problems occur with income and employment. The more informed you are about these issues, the easier it is to avoid them from preventing your loan approval.
The 3 C’s of Mortgage Underwriting
Mortgage approval relies on the 3 C’s of a mortgage application – credit, capacity and collateral. Credit, as the name suggests, is your credit score and credit history. Lenders look to see if you pay your bills on time, keep your extended credit to a minimum and avoid any negative credit events. This includes things like bankruptcies, foreclosures and judgments. Capacity refers to your ability to pay the loan back. This is an area of focus for underwriters – they need to see your current and historical income. Your job history plays a vital role in this step as it shows your loyalty and stability. This can predict your ability to repay a loan. The final “C” stands for collateral, which is the value of the property you wish to purchase/refinance as well as the amount of equity you have in the home or will use as a down payment.
Capacity is Important
Your capacity to repay the loan creates one of the largest obstacles to a loan approval. If you cannot prove steady income and employment, a lender cannot easily provide you with an approval. The most common red flags for this category include:
- Lack of a 24-month job history – The longer you remain at the same job, the more stable your income looks to a lender. If you job hop or have periods of unemployment, a lender cannot tell whether you are a good risk. They need to see not only current income, but also the likelihood of continuance. If you continually change jobs, the continuance for the foreseeable future is hard to predict.
- Inability to obtain a Verification of Employment – Most loan programs require the lender to conduct a Verification of Employment. This means the lender contacts your employer to verify your dates of employment and your position, among other factors. If the lender cannot get a hold of your employer, it serves as a red flag in terms of the likelihood of your employment.
- Handwritten income documentation – Any handwritten income documentation usually serves as a red flag as well. Your paystubs, W-2s and any other income documentation should be on official company letterhead or documents. Anything handwritten could easily be forged and are therefore, usually not accepted.
- Exceedingly high income for the position – Most lenders use sites, like Salary.com, to find the standard salary for your job in your area. If the amount of income you claim to make exceeds the standard amount by a large amount, the lender may become suspicious and need more information.
- Lack of tax returns – You must prove your income with the IRS whether you are self-employed or not. Most lenders require you to sign IRS Form 4506 which entitles them to the right to receive your tax transcripts. If there are no tax transcripts to obtain, the lender cannot use your income for qualifying purposes.
- Tax transcripts not matching your income documentation – Another issue with tax returns even if you are not self-employed occur when your tax transcripts do not match the documentation you provided the lender. Everything must line up in order to look official.
- Hopping from a salaried position to a commission-based position – Lenders want to see consistency with your income. This does not mean they do not allow commission-based employees to secure a mortgage; as long as the borrower received commission for at least 2 years, usually the lender can use it. If you recently switched to commission, however, you do not have enough of a history to qualify for a loan.
- Lack of money in bank – If the income you claim you make exceeds your monthly obligations by a significant amount, most lenders expect to see money in the bank. If you do not have any assets, they may wonder how realistic the claims you made are compared to your actual income.
Proving Red Flags Wrong
If your underwriter claims you have any of the above red flags, you need to know how to prove them wrong. The best way is to ensure every document you provide the lender is not only honest, but also official. Do not turn in handwritten documents or provide a cell phone number for your employer verification. You should only provide documents which state the truth and provide a clear picture of your income and employment history. If you know you have large gaps in employment, be ready to explain them with an official Letter of Explanation and if you changed jobs recently, you will have to explain why and how it impacted you financially.
Underwriters do not look at every aspect of your mortgage application in a negative way – they just need to make sure they protect the lender against default. If you have an odd situation where you know the underwriter might look at you funny, have a Letter of Explanation ready. This shows your knowledge of the industry and your willingness to comply with the needs of the lender before they can provide you with a loan approval.