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Loan Underwriting
 
 

Loan Underwriting

After reviewing the candidate's application and determining their creditworthiness, the next step in the process is for the loan officer-processor to secure the necessary funding.
Definition: Underwriting

Defined as a method for evaluating a customer's eligibility to receive a particular financial product, underwriting follows the lender as they assess the borrower's financial history against the amount requested, opts to either grant or deny financing, and produces the necessary documentation based upon proper procedural guidelines.

Secondly, as is the case with underwriting, at some point in time, the lender anticipates a return on the investment (ROI). This is an important factor as it tracks back to the individual lender's reputation, as well as, that of his lending institution.

Based upon the nature and the structure of the loan, the ROI tends to be reaped in accrued interest that either accompanies installment payments or as a lump sum paid out at a future date. In conjunction with underwriting, finance charges along with additional types of compensatory fees (such as a premium) are customarily included.
Not only does the underwriting process take into consideration the candidate's associated level of risk but also the candidate's willingness to hold up their end of the arrangement.
Thus, when approached by a potential borrower, a lender's responsibility is to do more than simply assess the individual's ability to repay a loan; they must also assess the borrower's desire to repay the loan.
Based upon the individual's past history of paying bills, the loan officer will strive to come up with an established bill paying pattern. While one or possibly two negative instances within an overall positive history may be overlooked, more than just a few instances may cause the loan officer to impose stricter guidelines or may refuse to even grant the loan request.
Credit History

According to conventional standards, a borrower with an extensive history of late payments or severe credit deficiencies may prove ineligible to finance. By the same token, individuals who previously defaulted on their mortgages or filed for bankruptcy are also deemed ineligible.

According to more contemporary standards, a borrower who can satisfactorily document the root of their credit problem along with the corrective measures undertaken, they may have an easier time securing a loan than someone who has not taken any steps to rectify the situation.

And, again based upon more contemporary standards, loan seekers who previously declared bankruptcy do not have to completely rule out getting a loan from a reputable lender.

For those with bankruptcy on their records, the possibility of obtaining financing still remains should a) sufficient time have passed (typically two to three years since the discharge of the bankruptcy) and b) efforts have been made to re-establish good credit.

However, in instances when the bankruptcy was the result of simple carelessness or poor financial management, a lender is likely to inflict longer waiting periods for the re-establishment of good credit.
Employment and Income

When reviewing a borrower's finances, specifically that of their employment status and income status, to assess their repayment potential, the underwriting considerations include: borrower's occupation, work stability, educational background, opportunities for future advancement on the job and employment financial incentives, for instance commission structures, built-in bonuses, and others.

The loan officer needs to receive signed (by both the employee-borrower and employer) verifications of employment (VOEs) with notations made in writing by the borrower as to any measurable gaps in employment.

In the event a borrower's employment history is less than two years, or they were previously in school or in the military, a copy of their diploma, transcript, or discharge papers will be needed to address questions pertaining to continuity of employment.


With respect to borrowers who are employed by a relative, work for a close, privately-owned business, or are considered to be contractual employees, copies of completed, signed tax returns for the most recent two-year period are required.

Risk Assessment

A favorable risk rating generally is given to a borrower who has demonstrated job stability in their line of work.

Within the risk assessment arena, some degree of job changing is recognized as normal. Frequent and successful job changing because a borrower has outgrown the job opportunities of the previous employer serves to indicate a positive employment trek.

However, a record of unemployment or excess job hopping without advancement often tends to raise concerns about an individual's ability to hold down long term employment and to remain economically stable. In such cases, in order for the borrower to qualify for maximum financing, an underwriter may feel it necessary to offer the borrower a loan with conditions* as a means of offsetting their financial liabilities.

*Note: When underwriters review a borrower's loan application, and they feel that it is missing qualifications needed for granting a perfect loan, the underwriters will call for some condition to be fulfilled prior to loan funding.

Such a condition could be almost anything pertaining to financial documentation. For example, it may entail having the borrower submit the last 12 months of bank statements or, perhaps, they may request the borrower to submit three additional credit references.
Commissions

With regard to commissions earned either as part time income, overtime, or as part of a bonus structure, these must be verified by the employer for a minimum of a two-year period. Furthermore, typically as a stipulation of underwriting, such verifications may be ongoing and, thus, called upon while going forward into the loan period.

Should income from the previously mentioned commission sources exceed 25% of a borrower's qualifying income, signed copies of completed tax returns and W-2 forms dating back two years (1099 forms if solely working on a commission basis) plus current pay stubs will be required.

Because the commission-based income is susceptible to yearly fluctuations, underwriters base such a variable worker's income on the average of their most recent two-year earnings.

Note: Some lenders opt to average the last three years in cases when the borrower works strictly on a commission basis.
Additional Sources of Revenue

A borrower may also provide documentation verifying the existence of dividends, interest earnings, and additional sources of investment income covering the last two years. Furthermore, with such revenue sources, typically documentation will indicate the continuance of such funding streams.

Proper documentation may include: photocopies of signed tax returns, bank account printouts, brokerage papers, and notarized, signed financial statements.

With respect to RE that serves as an investment, any income derived from rental property must be documented with a lease agreement, signed copies of completed tax returns dating back two years, and, when available, an operating income statement.

Underwriters qualify a borrower's income from investment property by taking an allowance deduction (not less than 25%) from gross rental income for vacancy, rental commission, management fees, and additional expenses. However, should the borrower be able to show zero vacancies for a two-year period and zero management fees, then it is possible for the 25% factor to be waived.

After subtracting the borrower's monthly debt service, principal, interest, taxes, insurance, and any remaining condominium fees from their qualifying income, should the resulting cash flow be positive, it is listed as income, if negative, it is listed under obligations.
Self-Employed

For those borrowers who are self-employed, they will need to provide signed copies of their tax returns from the past two years. Also required are copies of canceled checks for tax payments and, in cases when the loan value exceeds that of 80% of the individual's earnings, a certification from the tax preparer.

Plus, in instances when a self-employed individual has filed for an extension on their recent taxes, a copy of the extension request and copies of canceled checks sent to the Internal Revenue Service should also be included in their loan request package.

For those who own a minimum of 25% or greater ownership interest in a business, the lender may wish to request such information as: signed copies of partnership or corporation income tax returns with applicable schedules for the past two years, a business credit report, and current, audited (if possible) financial statements including internal financing statements in instances when more than four months had elapsed since the end of the last fiscal year.

Note: When the loan to value is under 80%, the previously stated requirements may not be required.
Automated Underwriting

Over the past few years, loan underwriting has evolved to incorporate the concept of automated underwriting. By merging technology with underwriting, it is now possible to evaluate the risk that a potential borrower poses of defaulting on a loan.

Capable of computing a risk associated number, the computer modeling program works by assigning numbers to various characteristics having to do with both the loan itself and the potential borrower. More specifically, the program evaluates the borrower's qualifications pertaining to income, credit, assets, and so on, and then evaluates the loan in comparison with the performance of other loans with similar characteristics.
Not all lenders, however, have made the leap to automated underwriting processes. Some still opt to rely on the traditional underwriting process where humans (as opposed to numerically assigned data) actually go step-by-step to evaluate the loan.
 
 
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