When submitting a loan for underwriting approval, it’s important to have an idea of the basic criteria your borrower will be judged on. In the most general terms, lenders want to make sure the borrower has the ability to pay, the willingness to pay, and the appropriate collateral in case they can’t pay.

Ability to pay
A borrowers ability to pay is measured by their income, the stability of that income, their assets, the amount of the loan payment, and their other credit liabilities.
Standards vary from loan program to loan program, but it’s very common that the lender wants to make sure the borrower makes at least 3 times his monthly mortgage payment. So if the monthly payment is going to be $2000 a month, they want the income to be at least $6000. This is commonly measured as a Debt ($2000) To Income($6000) ratio (DTI). Divide the income by the debt and you get 33%.
However, DTI is measured for both the payment and for all of the other credit bills that the borrower makes. So, The income is $6000, the mortgage payment is $2000, their car loan is $700, The Visa is $200, and the Sears card is $100 a month. Add all the debts together ($3000), now divide the income by this total number. In this case, the new DTI is 50%.
The two ratios are differentiated by the terms “front” and “back” ratio. 33/50 or a 33 front ratio and and 50 back ratio. I used some simple numbers here for clarity. In fact, this is on the high side for an acceptable DTI ratio. 28/36 was long a standard. Advanced underwriting engines have allowed this number to rise. The borrower’s employment history, and their saved assets can also effect how high the DTI can be. Borrowers with money saved for a rainy day and at the same job for the last three years are less of a risk than someone living month to month at a job they just started a few months ago.
You need to refer to the lender’s underwriting guidelines to determine the proper ratio, but at least now you know what to look for. I many cases the max DTI is subject to all of the other risk layers built into the loan. In such a case, you will just have to submit the loan to the lenders automated underwriting computer to see what it says.

Willingness to pay
Some borrowers may have the ability to pay their mortgage on time, but not the willingness. Willingness might mean the borrower would rather eat ramon noodles every night than miss a payment. It means they place their standing with the lender as a high priority. This willingness is measured by reviewing the history of the borrower’s current and past payment history. Usually this can be accomplished by ordering a credit history report. Credit reporting agencies evaluate the borrowers number of credit lines, available balances, and payment history. They also record unpaid collections and judgments. The information is graded in the form of a credit score.

Collateral
Residential Mortgages are usually secured by the real estate. For the purposes on a loan originator, they are always secured by real estate. Borrowers can offer a piece of real estate they already own as collateral, or the funds from a mortgage can be used to purchase a new collateralized property. Lenders want the present, or sometimes the near future value of the real estate to exceed the amount of the loan they are funding.
If a borrower is unable, or unwilling to to make their loan payments, sufficient collateral gives the lender the option to foreclose, (seize the property). But more importantly, it gives the borrower a chance to sell the home, which avoids the legal and marketing costs of foreclosing, and allows the borrower to recoup the equity they have invested in the home.
It’s better for the lender if the borrower can sell the property. Because of this, the value of the mortgage versus the value of the property is also important. This is known as the Loan To Value (LTV) ratio. If the property is worth $100,000, and the mortgage is $90,000, then the property has a 90% LTV. A lower LTV means the borrower has more equity in the home, and less likely to be willing to loose that equity through default.
Their are a number of reports that a lender may require to approve the offered collateral. The first is a residential appraisal that measures the property’s market value. The second is a review of property’s title. Sort of a credit check on the property itself. Title companies review the property’s legal status to ensure it is free of liens. These same title companies guaranty the review by offering an insurance policy to the lender. This is called title insurance. Additional reports can include flood plain certifications, surveys, and pest inspections.

Layering the risk factors
Traditionally, each of these criteria had fixed importance in the way the loan was underwritten. Today, most loans are fed into advanced, risk analyzed underwriting computer programs to determine a borrower’s overall risk level.
So for instance, a loan to a borrower with a strong credit history, and a low LTV might create some wiggle room for the DTI ratios to be higher than ideal. Or, a borrower with low DTI’s and strong credit may able to qualify for a higher LTV loan. Or, a borrower with strong credit, low LTV and low DTI’s may be eligible for a lower risk loan offered at a lower interest rate.
At first glance, reading a lender’s underwriting guidelines can be confusing. But by understanding the criteria the lender wants the borrower to meet, it starts to make a little more sense.

Todd Carpenter - lenderama