Chapter 8
Underwriting The Residential
Mortgage Loan
Underwriting is an integral part of the
mortgage lending process, regardless
of the type of loan or the type of property
securing the mortgage. Although
similarities exist in the underwriting of
the different types of residential
mortgage loans (conventional, FHA, VA)
the differences are more procedural
and not of great significance.
Understanding Risk:
The underwriting involved to determine the risk
requires the gathering and analysis of much
information about both the applicant and the real
estate that will secure the mortgage loan. On any
single residential loan, three separate
underwriting reviews could occur at various
stages of the mortgage lending cycle by the
following parties:
• Mortgage Lender
• Mortgage Insurer (Guarantor)
• Permanent Investor
A Mortgage Lender analyzes the risk and
determines whether to lend funds at a
certain interest rate to a borrower for a
period of time secured by a certain piece of
real estate.
A Mortgage Insurer determines if mortgage
insurance is to be written or a guarantee
made based on the loan as submitted.
A Permanent Investor determines if the
mortgage or mortgages as submitted will
be purchased.
Underwriting Guidelines:
No single uniform set of underwriting guidelines
exists for all residential mortgage loans. To a
great extent, the underwriting guidelines of both
Fannie Mae and Freddie Mac are the core
standards that most lenders attempt to follow.
Even those lenders who don’t intend to sell loans
to theses two secondary mortgage market
players should attempt to follow these well-
conceived underwriting guidelines.
Underwriting is an art not a science.
Loan-to-Value Ratios:
The lower the LTV ratio the safer the loan is for
the lender. The reason is that the lower the
LTV ratio, the higher the equity investment the
borrower will have in the property and thus
the more that borrower has to lose.
______Mortgage_Amount___________ =LTV
Lesser of Sales Price or Appraised Value
Down Payment (Equity):
The money for the down payment (equity)
can come from any liquid investment
source
The existence and history of these funds
should be established by a Verification of
Deposit (VOD).
• When was the account opened?
• How long have the funds been there?
• In what name(s) is it held?
Income Ratios:
The most important test of whether an
applicant can afford a particular mortgage
loan is by computing the various income
ratios.
Borrower Income:
Income Sources include these:
• Regular wages
• Part-time employment • Self-employment
• Working spouse • Bonuses
• Rentals • Dividends or interest
• Alimony or child support • Retirement annuity
• Commissions • Social security
• Public Assistance
The underwriter must judge that the
income is likely to continue. The income
must be verifiable.
Estimating Housing Expense:
Principal and interest on the mortgage being
applied for.
Mortgage insurance (if any).
Property Taxes
Hazard Insurance
Condominium or cooperative homeowners
association dues (if applicable)
Other Obligations:
Borrowers will have other obligations,
examples include:
• auto loans,
• credit card accounts,
• other mortgage debts,
• or alimony and child support payments.
Housing Expense Ratio
Housing Expenses
Borrower’s Income
< 28% (CONVENTIONAL LOAN)
Total Obligations Ratio
Total Obligations
Borrower’s Income
< 36% (CONVENTIONAL LOAN)
Higher Ratios may be justified by
mitigating factors, such as:
Demonstrated ability of an applicant to
allocate a higher percent of gross income
to housing expenses
Larger down payment than normal
Demonstrated ability of an applicant to
accumulate savings and maintain a good
credit rating
A large net worth
Potential for increased earnings because
of education or profession
FHA Ratios are:
29 percent for the mortgage payment ratio
41 percent for the total debt ratio
VA Ratios are:
The VA uses a modified residual method in
qualifying a veteran for a mortgage loan,
and this result is then double-checked
against a total debt-to-income ratio of 41
percent.
Loan Classifications
Conventional Mortgages
Insured conventional mortgages
FHA insured mortgages
VA guaranteed mortgages
“Sharing Default Risk”
Conventional Mortgages:
Not insured or guaranteed by federal
agency
Maximum LTV Ratio of 80% (occasionally
higher)
Private mortgage insurance (PMI) usually
required on purchases with down
payments <20%
PMI enables lenders to settle for low
(perhaps as low as 5%) down payments.
Most PMI policies cover top 20-25% of the
mortgage.
Advantages of PMI
Borrower can buy house that might not
pass VA or FHA inspection
Allows small down payment
Premiums are lower than FHA because it
doesn’t cover entire mortgage
Processed quicker than FHA
PMI can be canceled when LTV < 80%
Rates are determined by market
PMI allows lender to sell mortgage in
secondary market
Credit History
Credit Report:
• Identifying section
• Info on age, marital status, dependents,
employment, etc... - applicant and co-applicant
• Credit record
• Public Records data
The Closing Process
•The purpose of the closing is to make
final settlement between the buyer and
seller for costs, fees, and prorations
associated with the real estate
transaction prior to the transfer of title,
and to finalize the loan agreement
between the buyer/borrower and the
lender.
Fees and Expenses
Financing costs:
1. Loan application fee
2. Credit report fee
3. Loan origination fee
4. Lender’s attorney’s fees
5. Property appraisal fee
6. Fees for property survey
7. Fees for preparation of loan
amortization schedule
8. Loan discount points
9. Prepaid interest
Prorations, Escrow Costs, and
Payments to Third Parties
Property Tax, Prorations, and Escrow
Accounts
Mortgage Insurance and Escrow Accounts
Hazard Insurance and Escrow Accounts
Hazard Insurance and Escrow Accounts
Mortgage Cancellation Insurance and
Escrow Accounts
Title Insurance, Lawyer’s Title Opinion
Release Fees
Attorney’s Fee
Pest Inspection Certificate
Real Estate Commission
Statutory Costs
Recording fees. Fees paid for
recording of the mortgage and note
in the public records.
Transfer tax. A tax usually imposed
by the county on all real estate
transfers.
Requirements under the Real
Estate Settlement and Procedures
Act (RESPA)
The essential aspects of RESPA fall into
seven areas that are used here to
facilitate discussion:
1. Consumer information
2. Advance disclosure of settlement costs
3. Title insurance placement
4. Prohibition of kickbacks and referral fees
5. Uniform settlement statement
6. Advance inspection of uniform settlement
statement
7. Escrow deposit
Settlement Statement
I. Amount Due from Buyer: II. Amount Due to Buyer:
(A) Purchase Price $76,700.00 Sale Price $76,700.00
Plus: Settlement Charges 2,909.69 Plus: County tax proration 615.76
County Tax Proration 615.76
Less: earnest Money 1,000.00 Less: Payoff of existing loan 21,284.15
Mortgage Loan 61,360.00 Settlement charges* 4,607.00
Net Amount Due from Buyer $17,865.45 Net amount due to seller $51,424.61
Buyer’s Share of Settlement Changes: *Seller’s Hare of Settlement Charges:
Loan origination fee $614.00 *Broker commission $4,602.00
Loan Discount 614.00 *Recording fee 5.00
Appraisal fee 125.00
Credit report 45.00
Mortgage insurance Application fee 50.00
Interest (7 days @ $15.55) 108.85
Homeowners insurance 552.00
2 months premium-escrow 92.00
2 months property tax-escrow 132.84
Title insurance (lender) 100.00
Recording fee 31.00
Closing fee 75..00
Title insurance 350.00
Pest inspection 20.00
Total $2,909.60 Total $4,607.00
