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Residential Mortgage Lending:
Principles and Practices, 6e
Chapter 13
Underwriting the Residential Mortgage Loan
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Objectives
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After completing this chapter, you should be able to:
– State the purpose of underwriting guidelines
– Explain why the initial interview is so important to the underwriting
process
– Identify the different types of risks analyzed in the underwriting
process and the effect on pricing
– Calculate the different kinds of ratios commonly used in underwriting:
loan-to-value, housing expense, and total debt
– List the types of information analyzed by the underwriter in each of
these areas: applicant’s financial capability; applicant’s credit history;
and the collateral (real estate) securing the mortgage
– Compare Automated Underwriting Systems to Manual Comprehensive
Risk Assessment Guidelines
– Understand the issues behind discrimination in mortgage lending and
what the Federal Government has done about this activity
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Residential Loan Risks
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Credit—based on the credit history of the applicant
Collateral—the condition and value of the property being secured
Default—the repayment of the debt
Fraud—approval and pricing based on intentional deception
Compliance—failure to follow all state and federal regulations involved
Interest rate—changes in market interest rates vs. loan interest rate
Price and market—changes in the value of the loan before it is sold
Liquidity—either lack of funding for a loan or prepayment of an existing
loan
Secondary market—several risks, including losing an investor or
program
Portfolio—changes in market value due to internal or external conditions
Servicing—changes in market value or failure to meet servicing
requirements
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Three C’s of Lending
• Capacity – do the applicants have the financial
resources to repay the proposed and existing
debts?
• Credit – do the applicants have an acceptable
credit history? Have they used credit
responsibly?
• Collateral – is the property sufficient collateral
to secure the loan?
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LTV = Mortgage Amount ÷ Lesser of
Sales Price or Appraised Value
● 90% LTV loan is twice as likely to default as an
80% LTV loan.
● 95% LTV loan is nearly three times the default
risk as an 80% LTV loan.
● 97%LTV loan is nearly six times the default
risk as an 80% LTV loan.
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Credit Scores
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Underwriters Review of Appraisal
1. Location/Site. This is always the most critical of all evaluating factors.
a. Property must be residential in nature, not agricultural or commercial.
b. Adequate sewage and water facilities and other utilities are present.
c. Property is readily accessible by an all-weather road.
d. No danger is posed to health and safety from immediate surroundings
(including environmental hazards).
2. Physical security. The age, equipment, architectural design, quality of
construction, floor plan, and site features are considered when
establishing the adequacy and future value of the physical security.
a. Evidence of compliance with local codes should be in the file for
underwriter’s review.
b. Topography, shape, size, and drainage of a lot are equally important.
c. View, amenities, easements, and other encroachments may have either
a positive or negative influence on market value.
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Underwriters Review of Appraisal
3. Local government.
a. The amount of property tax can have a great effect on future
marketability.
b. Building codes, deed restrictions, and zoning ordinances help to maintain
housing standards and promote a high degree of homogeneity.
4. Comparable sales. This is a critical section for residential real
estate loans.
a. The comparables are truly similar to the subject in regards to location,
type of real estate, and time of sale.
b. The adjustments exceed 10 percent for any line item.
c. The total of all adjustments, disregarding plus and minus signs,
exceeds 25 percent.
d. Adjusted sales prices “bracket” the market value of the subject property.
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AUTOMATED UNDERWRITING
SYSTEMS
• Determines the creditworthiness of an
applicant by having a computer software
program assign values to certain attributes
and facts for each application.
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UNDERWRITING GUIDELINES
• The lender’s underwriting standards should be
clearly written, nondiscriminatory, and
available for review by the general public.
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UNDERWRITING Decision
• When the lender has a fully processed
mortgage loan application, the lender makes a
credit decision that either accepts, rejects, or
modifies the mortgage loan application.
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What Do You Think?
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Identify the types of risks present in
residential mortgage lending. Which of
these does an underwriter evaluate?
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How do underwriting guidelines mitigate the
risks in mortgage lending?
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What are the pros and cons of Automated
Underwriting Systems?
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What Do You Think?
•
How does the Loan-To-Value (LTV) and
Combined LTV (CLTV) affect the way the
underwriter reviews a mortgage
application? Why are these ratios so
important?
•
What compensating factors might offset a total
debt ratio that exceeds a lender’s
guideline?
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What Do You Think?
•
What are credit scores? How does the
secondary market use credit scores and how
are they different from mortgage scores?
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In what ways does a “Comprehensive Risk
Assessment” differ from other underwriting
reviews?
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Check Your Understanding
1. Underwriting is the process of analyzing risk.
2. In underwriting residential mortgage loans, the lender
should follow a strict formula.
3. Uniform underwriting guidelines exist for all residential
mortgage loans.
4. When it is obvious that a potential borrower is not
qualified, the lender should decline to take the
application.
5. Once an application is submitted to the lender, the
lender is subject to disclosure requirements.
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Check Your Understanding
6. It would be improper for the lender to counsel an
applicant during the initial interview.
7. Lenders should have a written underwriting and loan
policy to review with potential borrowers.
8. Long-term debt is defined as monthly obligations
extending more than three years into the future.
9. Acceptable ratios for housing expenses and long term
debt for conventional and FHA loans are both based on
gross monthly income.
10. One way of verifying a self-employed applicant’s income
is to review federal income tax returns from previous
years.
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Check Your Understanding
11. HUD-FHA regulations define housing expenses as
principal and interest payments.
12. The appraisal establishes the adequacy of the security
as well as the loan-to-value ratio.
13. The appraiser in estimating property value considers
building codes and zoning ordinances.
14. To reject an application because of the property’s
location and neighborhood is discriminatory.
15. Income from a part-time job may not be considered
when evaluating the financial capability of the
borrower.
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Check Your Understanding
16.Use of investigative reports relating to the applicant’s
character and reputation is permissible.
17.Under the Equal Credit Opportunity Act (ECOA), a lender
must certify to consumer reporting agencies the purpose for
which the credit information is to be used.
18.ECOA permits asking if applicants are married or unmarried.
19.Lenders have 30 days from the date of application in which
to notify the applicant whether the loan request has been
approved or rejected.
20.Attitude toward credit needs to be considered only when the
applicant’s income does not qualify.
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