January 26, 2020

mortgage underwriting

As an investor looking for a mortgage or a loan to buy real estate, you have to jump through numerous hoops. The obstacles to purchasing a house to flip or rent seem impossible but the more you know about the process, the easier it will be.

One of these obstacles is having a real estate underwriter evaluate the property you want to buy.

We’re going to go over everything you need to know about underwriting real estate and what to expect when dealing with an underwriter.

What is Underwriting for Real Estate?

A real estate underwriter is assigned by your lender to asses the risk of loaning you money to purchase a property. They also assess the return that they’ll receive if they do offer you a loan or mortgage.

Lenders use underwriters to determine whether or not it’s a good investment for them to lend to you. The underwriter goes over your loan and credit history. If you have a bad credit history, chances are they’re not going to trust you enough to loan you money.

They also have to examine the house or property you want to buy to make sure it’s worth the investment. The sales price has to meet the appraised value. They ask for an appraisal by a third party. If you default on the loan, they want to make sure the property itself makes up for that loss.

Underwriters decide if you get the loan and how much you’ll receive from the lender by determining the debt-service coverage ratio or DSCR.

They will either approve your loan, deny your loan, or suspend your loan. If your loan is suspended, it means they don’t have all the information they need to determine whether to approve or deny.

Once you give them all the needed information, your loan application becomes active again.

Two Test Mortgage Underwriting Process

An underwriter figuring your debt-service coverage ratio isn’t quite as complicated as it sounds. It’s just a way to determine your cash flow and your ability to pay your obligations, including the loan you’re applying for.

Not only do they want to make sure you make enough to pay off the loan and your other debts but they also want to make sure you have money left over in case anything serious happens in your life that affects your finances.

There is a specific formula a real estate underwriter uses to figuring out a person’s debt-service coverage ratio.

1. First, they determine your net operating income.

Your net operating income is how much income the property will bring you each month.

This amount needs to be more than the cost of expenses you’ll be paying each month.

To figure this out, they take your certain operating expenses and subtract that amount from your revenue.

2. Next, the underwriter must determine the loan to value ratio.

This is where the appraisal of the property comes into play.

A loan to value ratio is the ratio between the amount of your loan and how much the property is worth in an appraisal. This ratio is based on a percentage once all the math is done.

To calculate the loan to value ratio, the loan amount is divided by the property value or appraisal value. The lower the ratio, the better as it means there’s less risk for the lender.

3. Determine the Debt-Service Coverage Ratio

To determine your debt-service coverage ratio, they divide your net operating income for each month (or year) by your total debt service for each month.

If your debt-service coverage ratio is less than one, you have negative cash flow. You aren’t making enough to pay both your current debt obligations with cashflow from the property. Instead, you’d have to dip into reserves or other revenue sources.

Most lenders prefer that your Debt-Service Coverage Ratio be at least the amount of 1.25 or more. The higher the number, the less risk for the lender.

4. Two Tests For Maximum Loan Balance

To decide how much the lender should loan you for the property, the underwriter does a maximum loan analysis.

A maximum loan analysis takes into consideration the net operating income, loan to value ratio, and the debt-service coverage ratio.

They use your net operating income and divide it by the debt-service ratio to determine one amount.

Next, they divide your net operating income by the loan to value ratio for a second amount they could loan to you.

Between the loan to value ratio and the debt-service coverage ratio, they choose the lesser number for the amount of money you’ll receive for your loan.

This is just a simplification of the loan and real estate underwriting process. Other variables can come into play when determining if you receive a loan or how much you should receive.

Additional Requirements For Being Approved by a Real Estate Underwriter

There are several steps when it comes to underwriting real estate and deciding whether your loan or mortgage application should be approved.

Since a real estate underwriter has to also examine the appraisal of the property, they’re most likely going to manually underwrite your loan.

We’ll go over each step so you can get an idea of what you’re in for when you sign up for a real estate loan.

1. You Have to Deliver All Your Financial Information

Underwriters review all of your financial information to make a decision. There are loads of documents you have to provide and documents you have to fill out for the underwriter.

These are the most common documents that the underwriter is going to ask from you:

  • Verification of your identity through a driver’s license or social security card (there are other forms of identity underwriters will accept)
  • Verification of your address through a bill or piece of mail (there are other forms of verification of your address underwriters will accept)
  • Verification of income (usually up to 12 months of pay stubs)
  • Verification of employment by providing your employer’s contact information
  • Either your most recent tax returns or a few years worth of tax returns
  • Your bank account and savings account information
  • Verification and information on all your assets (from your vehicles to other homes you own)

If you own a business, they may ask you for more types of documentation, including a way to verify that you do run your own business.

2. Your Credit History Will be Checked

This should be a no-brainer but your credit history and credit score are reviewed by the real estate underwriter.

First, this gives the underwriter an idea of how much you owe for other loans, from car loans to personal loans. It also takes into consideration other payments you make each month.

First, they get an idea if you’re in over your head in debt payments already, before taking on another loan.

Secondly, they see where your credit score ranking is as of the time you’re asking for your loan or mortgage.

If your credit score is low, it shows that you may not be very responsible when it comes to paying your bills. A high credit score gives the underwriter more confidence that you’ll repay the money they lend to you.

Lastly, they look at how consistent you pay bills and debts.

The better your credit history, the better you look to the real estate underwriter.

3. Your Assets and Income Will be Evaluated

After you’ve proven your assets and verified your income, the underwriter goes through the details of both.

One thing they have to check is if your income is stable. It’s better if you’ve been at the same place of employment for two years or your business has been making a decent amount of profit for the past few years.

This ensures that you’ll continuously have income coming in and how much that income is.

Your income should be over what your monthly bills and debt payments are.

They also have to determine your assets which can include other property you own, vehicles you own, and if you have any money in a savings account. This way they know that if something major happens, you still have enough money to cover all your expenses, bills, and the loan payment.

4. Your Collateral Will be Considered

Your collateral is your down payment on the loan. Some lenders and loan programs for personal mortgages can go as low as 3.5% of the loan as a down payment but for commercial mortgages it will be 20-25%. If you want to pay more, you look even better to the underwriter and the lender.

The underwriters double-check to see where the money for your down payment is coming from. It has to be money that you already have. It’s frowned on to take out a loan to pay a down payment on another loan.

This is also the step in which the real estate underwriter brings in a third party to appraise the house or property you want to buy.

The appraiser determines the amount the property is worth so that you’re not overpaying nor is the lender loaning you too much for the property.

The land is also surveyed so the underwriter gets an idea of the property and house layout, which includes property lines.

Lastly, they receive a copy of the title insurance on the property. This is to ensure that there are no liens on the property or even previous unpaid taxes that would have to come out of our pocket.

Final Thoughts

The real estate underwriting process has its ups and downs. Even after you’ve provided all the documentation that the underwriter needs, it takes them time to go through all the information and get an appraisal on the property.

Don’t let the wait to find out whether you’ve been accepted or denied worry you. It’s normal and, in the end, worth it to find out whether or not you can close on that property that you want so much.

About the author 

Eric Bowlin

Eric is an investor that achieved financial independence at the age of 30. He started in 2009 with the purchase of his first triplex and now owns over 470 rental units. He spends his time with his family, growing his businesses, diversifying his income, and teaching others how to achieve financial independence through real estate. Eric has been seen on Forbes, Trulia, WiseBread, TheStreet, Yahoo Finance and other financial publications. You can contact Eric by emailing him at [email protected] or with this contact form

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