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What the lenders look for -- and
how you can use that information

Mortgage lending secrets revealedNow that Fannie Mae has let the Desktop Underwriter cat out of the bag, what should borrowers know about it? For starters, the system considers 14 factors when evaluating a mortgage. Some are related to the parameters of the desired loan while others pertain to the borrower. They are:

  • Equity (the appraised value or sale value of the home minus the loan amount)
  • Credit history (as measured by the FICO credit score)
  • Liquid reserves (the amount of liquid assets, such as cash left in a checking account, after the loan closing divided by the monthly mortgage payment)
  • Total debt-to-income ratio (the amount of monthly debt payments for the expected mortgage, existing car loans, credit cards, etc. divided by gross monthly income)
  • Borrower's work status (Is the borrower salaried or self-employed?)
  • Loan term (How many years will the loan be on the books?)
  • Rate and payment structure (Does it have an adjustable rate or balloon payment?)
  • Number of units (Is the borrower buying a two-unit property and renting out one of them, e.g.?)
  • Co-op, condo or attached (Is the borrower purchasing a condominium or house, e.g.?)
  • Funds from other parties (Is much of the down payment coming from mom?)
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  • Loan purpose (Is it for a home purchase or refinance? If it's a refinance, is cash being taken out at closing? If so, how much?)
  • Number of borrowers (How many people are on the application?)
  • Prior bankruptcies or foreclosures
  • Prior mortgage delinquencies

The top three factors
Of these factors, Fannie Mae says that the three most important are equity, credit history and liquid reserves. The system considers a loan better if the borrower has more invested in the transaction via a higher down payment. It also likes borrowers who have managed finances well and have a fair amount of money left over in the bank after closing because that provides a cushion against default risk.

Some of the remaining factors are self-explanatory. The system considers someone who was 60 days late on a mortgage payment within the past two years and a borrower who filed for bankruptcy in the past as riskier.

Others are a little less clear. If a lot of down payment money comes from someone else, for example, it's not necessarily bad. But borrowers who put hardly any of their own money into the transaction, or those who receive assistance in the form of a personal loan from their parents rather than as a gift, might be considered riskier.

For things such as loan term, the systems consider a 30-year fixed rate mortgage less risky than an adjustable rate mortgage. That's because borrowers default less frequently on stable, long-term loans. At the same time, 15-year mortgages are considered less risky than either because they default even less frequently than 30-year ones.

Employment history can be looked at in a couple of ways as well. A Freddie Mac spokesman points out that Loan Prospector looks at consistency of earnings, rather than just how they're made. So, a contractor who has been in business for several years might score just as well as someone who has worked for six companies in four years.

With loan purpose, there's nothing better or worse about a straight refinance loan. But if somebody is taking cash out at closing such that the loan-to-value ratio rises too high, the system might raise a red flag. The same goes for a borrower who buys a multi-unit property with the intent of renting out part of it. While there's nothing wrong with doing so, there might be problems if the consumer couldn't make the mortgage payment without the rental income.

One last thing: Having a coborrower on the application can improve the prospects for approval somewhat.

Consumers should remember these are just guidelines. The systems compare application data in such a manner that strength in one area can compensate for weakness in another, too. Don't assume that you won't qualify just because you're getting a few thousand dollars in down payment assistance from your parents.

Randy Johnson, a Newport Beach, Calif. mortgage broker who wrote How to Save Thousands of Dollars on Your Home Mortgage, remembers one borrower who wanted to refinance her home loan about a year ago. A Christian schoolteacher, she didn't make much money and was stuck with a total debt to income ratio of around 55 percent. But the loan was for only about $105,000 on a $400,000 home. Along with that low loan-to-value ratio, she had money in the bank and a stellar bill-paying history. As a result, the automated underwriting system approved the loan.

What happens next?
So once the systems run their computations, what happens next? Both agencies respond to applications in one of three ways; the following three answers come from Desktop Underwriter:

  • Approve -- The agency will most likely buy the loan because it shows little risk of default.
  • Refer -- The loan needs to be reviewed by a human underwriter to clear up data questions, but it may very well be purchasable.
  • Refer With Caution -- The mortgage doesn't look like it will pass the test, so a human underwriter has to review it.

Even if you think you're all set, there are instances where Fannie Mae's system will give a loan a refer rating no matter what. This happens when:

  • The borrower's debt to income ratio is "unusually high?" The agencies won't clarify what that means, but they do say the ratio would have to be much higher than the 36 percent to 38 percent level that some lenders consider risky.
  • The borrower has less cash in the bank than is needed to close. If Joe has $8,000 to buy a house and he pays $4,000 in closing costs and $4,000 as a down payment, everything's peachy. But if closing costs were $5,000, the system would refer the loan.
  • A bankruptcy or foreclosure appears on the credit report with no date known.
  • The borrower declares either of those problems but the credit report doesn't have a record of it.

Armed with this information, consumers can go into their lenders' offices knowing what might trip them up.

A self-employed borrower who is getting down payment money from the parents to buy a duplex with an adjustable-rate mortgage may want to consider a longer-term rate lock, for example, because closing will likely take a while. Somebody with hardly any cash reserves may want to consider saving more money, too, rather than waste time and money applying for a loan they may not get. At the very least, lenders say, consumers should familiarize themselves with what they're being graded on before they take the test.


-- Posted: Feb. 3, 2000
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See Also
Main story: Secrets of automated underwriting revealed


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