If you are planning to apply for a mortgage loan, you may have heard of the term "underwriting". Underwriting is the process by which lenders evaluate the risk and eligibility of a borrower and the property they want to purchase or refinance. Underwriting involves verifying the borrower's income, assets, credit history, and debt-to-income ratio, as well as appraising the value and condition of the property.
One of the tools that underwriters use to assess the borrower's ability and willingness to repay the loan is the 3 C's of mortgage underwriting: capacity, credit, and collateral. Let's take a closer look at what each of these factors means and how they affect your chances of getting approved for a mortgage.
Capacity
Capacity refers to your ability to make your monthly mortgage payments on time and in full.
To measure your capacity, underwriters will look at your income, employment history, and debt-to-income ratio. Your income should be stable, consistent, and sufficient to cover your housing expenses and other obligations. Your employment history should show that you have been working in the same field or industry for at least two years, or that you have a strong track record of increasing your income over time. Your debt-to-income ratio is the percentage of your gross monthly income that goes toward paying your debts, such as credit cards, car loans, student loans, etc. The lower your debt-to-income ratio, the more likely you are to qualify for a mortgage. Generally, lenders prefer borrowers who have a debt-to-income ratio of 36% or less, although some loan programs may allow higher ratios depending on other factors.
Credit
Credit refers to your willingness to repay your debts and your history of managing your finances responsibly.
To measure your credit, underwriters will look at your credit score, credit report, and payment history. Your credit score is a numerical representation of your creditworthiness based on various factors such as payment history, amount owed, length of credit history, types of credit used, and new credit inquiries. The higher your credit score, the more likely you are to qualify for a mortgage and get a lower interest rate. Generally, lenders prefer borrowers who have a credit score of 620 or higher for conventional loans and 580 or higher for FHA loans, although some loan programs may have different requirements depending on other factors. Your credit report is a detailed record of your credit history that shows your accounts, balances, payment history, collections, bankruptcies, etc. Your credit report should be free of any negative items that could indicate a high risk of defaulting on your loan. Your payment history is one of the most important factors that affect your credit score and underwriting decision. You should have a history of paying your bills on time and in full every month without any late payments, delinquencies, or defaults.
Collateral
Collateral refers to the property that you want to purchase or refinance with the mortgage loan.
The property serves as security for the loan in case you fail to repay it. To measure the collateral value and condition, underwriters will look at the appraisal report and title report. The appraisal report is an independent evaluation of the property's market value based on its location, size, features, condition, and comparable sales in the area. The appraisal report should support the purchase price or loan amount that you are requesting and show that the property meets the minimum standards for safety, soundness, and habitability. The title report is a document that shows the legal ownership and history of the property. The title report should be clear of any liens, encumbrances, easements, or defects that could affect your rights or interests in the property.
The 3 C's of mortgage underwriting are essential factors that lenders use to determine whether you qualify for a mortgage loan and how much you can borrow. By understanding what underwriters look for in each of these areas, you can prepare yourself better for the mortgage application process and increase your chances of getting approved for the loan that suits your needs and goals.
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