Mortgage & Wealth Strategies

How Do Lenders Decide Whether To Approve or Decline A Mortgage Application?

December 19, 2021 | Posted by: Matt Broom-Hall

So you’ve finally decided to buy your own home and go through the process of applying for a mortgage. Like any first-time home buyer, you probably have a ton of questions on what happens behind the scenes of mortgage loan processing. The entire process, known as underwriting, still remains a mystery to many mortgage applicants, even after receiving full approval.

What is Underwriting?

Mortgage underwriters are the fact-checkers of the home loan approval process. They practically ensure that the financial picture you portrayed in your application is accurate and true. The entire underwriting process assesses your creditworthiness and your ability to repay a mortgage, among other things. 

The 4 Cs of Mortgage Qualification

To simplify things, underwriters look at four key factors to determine whether an applicant such as yourself qualifies for a loan or not. Let’s discuss these four Cs and how underwriters look at them.

Credit

The most well-known among the four Cs is that dreaded report that tells your entire debt and repayment history called credit. Basically, credit refers to the prediction of borrowers’ repayment based on their credit history analysis. These reports are extracted from the two credit reporting companies in the country: Transunion and Equifax. 

Your payment history, total debt compared to available debt, and even the types of debt you have will all factor in on the credit score you receive from these companies. The higher the score you have, the higher chances of your loan application being approved since you have a lower risk.

Capacity/Income

While your credit speaks of your past debt and how you managed to repay them, capacity focuses on your ability to repay your mortgage over time. Underwriters perform this analysis by looking at your debt-to-income ratio. Simply put, your debt-to-income ratio is the sum of all your monthly payment obligations, including the one you’re applying for, divided by your gross monthly income. This gives them an idea of how much you can pay considering all your other expenses.

Collateral/Property
Collateral refers to the security of your loan in case of any issue that may arise that will prevent you from paying them back. This is usually done by appraising the value of your home. Essentially, they are investigating every aspect of the property, including the location, size, condition of the house, cost to rebuild it, and even rental income options. Obviously, loan officers and lenders don’t want to foreclose, but they do need to have something to secure the loan, in case you become delinquent with your payments.

Capital/Equity/Down Payment

Finally, capital is a review of your finances after you close, which involves cash in the deal and your cash in reserves. The former means the more of your own money involved, the stronger the loan application. Simply put, if you compete with another buyer with practically the same risk levels and credit scores, the one with more money after closing the deal stands as the winner.

On the other hand, cash in reserves determines if you have a financial cushion to fall back on if your income is suddenly interrupted. 

Looking at all these factors, a mortgage broker and underwriter’s job may seem a little more complicated than you would imagine. With all those considerations, there’s no wonder why the application process can take some time to close and why people still get denied even if they nailed three out of those four Cs. It goes to show how thorough the entire underwriting process is and why borrowers should take it seriously. 

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