The Benefits of Manual Mortgage Underwriting

When you’ve found the home of your dreams, the next adventure begins when you apply for a mortgage and start nailing down the details. As one of the steps of qualifying for a mortgage, the underwriting process can be smooth as silk or it can turn into a real nail-biter. But even if your underwriter denies your mortgage, you may still have an ace in the hole. The manual underwriting of a mortgage is an option that may override the automated process and turn a declined mortgage application into an acceptance.

A mortgage underwriter is your lender’s representative who is ultimately responsible for denying or approving your mortgage. Lenders depend on underwriters to determine if potential borrowers have the ability to repay a mortgage. An underwriter, or a loan specialist working with the underwriter, verifies the information on a borrower’s application, such as employment, income and credit. If the mortgage file is incomplete or needs additional documentation, the underwriter will send it back to a loan officer for completion or revision.

The three primary categories that an underwriter considers before approving a mortgage loan are a borrower’s credit score, capacity to pay and collateral risk.

1. Although a credit score is a snapshot of a borrower’s debt burden and payment history, it doesn’t reveal income, net worth or cash reserves, which is why it’s only one component of underwriting a mortgage.

2. The capacity to pay addresses a borrower’s employment, income, assets and liabilities. A consistent income for at least two years typically is needed, backed up by paperwork such as pay stubs and tax returns. Bank statements or investment statements confirm a borrower’s cash reserves, which will cover the loan closing costs and fees as well as the down payment. Liabilities that could hinder a mortgage approval must be disclosed, including debt and financial responsibilities, such as alimony and child support.

3. A borrower’s collateral risk confirms the value of a home to make sure the loan amount is backed by sufficient value in case of default. Instead of assigning an arbitrary value, the lender orders an appraisal and confirms the absence of liens, judgments and unpaid taxes on the property.

When an underwriter pulls together each piece of the underwriting puzzle to approve or deny a mortgage loan, it’s often computer software that does the evaluating in a process called automated underwriting. Conventional loans that must conform to Fannie Mae guidelines use a program called Desktop Underwriter® (DU) to perform a credit risk assessment of each borrower. (Freddie Mac's underwriting software program is called Loan Product Advisor®.) Although borrowers must still provide documentation to support the data they include with their loan application, automated underwriting offers a fairly streamlined approach to mortgage approval.

After a mortgage application goes through the automated underwriting process, results are returned with one of four designations: approve/eligible, approve/ineligible, refer/eligible and refer with caution. Borrowers hope to fall in the approve/eligible category, because this means their mortgage has a preliminary approval, pending the verification of the paperwork they submitted. Although the word “ineligible” in the second category may appear to be a deal breaker, it typically means that something in the loan package didn’t exactly conform to the underwriting guidelines, and it needs a second look to cure the deficiency. If an automated underwriting submission returns a refer/eligible or refer-with-caution finding, the word “refer” sends the loan back to the underwriter, who may initiate another method of evaluating the mortgage loan – the process of manual underwriting.

Although an underwriter may still use a computer to perform certain calculations or research some of the data on a borrower’s referred-status loan application, manual underwriting is more of a hands-on approach. The underwriter digs a little deeper to construct a more comprehensive look at a borrower’s financial situation instead of relying on a computer-generated assessment of the lender’s risk. The refer-with-caution classification is a red flag that signals significant risks with approving the loan. But the refer/eligible classification often indicates that the borrower may be eligible for loan approval after a few tweaks by the manual underwriting process.

In a perfect mortgage world, automated underwriting would deliver perfect results to approve or deny all loans. But all borrowers don’t neatly fit into the cookie-cutter mold that computerized processing creates. Even in today’s digital world, manual processing is still the remedy for turning a mortgage denial by a computer into a mortgage approval by a human underwriter.

In an industry where credit is king, credit issues alone can kill the deal for mortgage approval through the automated underwriting process. But the manual underwriting process digs deeper into a borrower’s credit history to get a more comprehensive look at her overall financial picture.

Manual underwriting of a home loan benefits borrowers in different financial situations, including:

• Bad credit. Bad credit is, of course, a stumbling block to mortgage loan approvals. Late payments, collections, bankruptcies and foreclosures can put blemishes on a credit report that lower credit scores and generate loan rejections through the automated process. Sometimes, however, a credit report simply needs to be "cleaned up," which a proactive underwriter may be willing to help a borrower do through a manual underwriting project.
• Thin credit. For borrowers who are still working to build a strong credit profile, their credit score may not yet be high enough to qualify through the automated process. A manually underwritten mortgage may introduce compensating factors, such as a high net worth, which can offset thin credit.
• No credit. There is such a thing as no credit, which is not the same as bad credit. Some people choose a debt-free lifestyle by not using credit cards or taking consumer loans, for example, both of which create a credit history of borrowing and repaying. But when a credit report virtually is a blank slate, lenders don’t have an overall picture of a borrower’s creditworthiness. Manually underwriting this type of mortgage includes factors that are not visible on a credit report, such as a high net worth, which may kick an initially declined loan into acceptance status.

• High DTI. A borrower’s debt-to-income ratio (DTI) expresses the relationship between his monthly gross income and his total monthly debt. The requirements for DTI vary, depending on loan type and other factors. But when a borrower's DTI is outside the parameters for a specific mortgage, a manual underwriting review may approve the loan because of compensating factors. For example, a borrower may not initially qualify for a Veterans Affairs loan with a high DTI, but the VA considers residual income as a compensating factor. If a borrower has enough "money left at the end of the month," a

  manual underwriting of the VA loan includes this residual income, which may override high DTI and make it possible to qualify for the loan.  * Self-employment. Self-employed borrowers don’t fit into the black-and-white mold of mortgage qualifying. Their income may vary because of seasonal fluctuations or other variables, and their business expenses may cause erratic adjustments to their incomes.