Lending standards are back and now it's tougher to qualify for a home loan than it was just a few years ago. Today, lenders are still relying on your clients credit scores to determine whether they are a good risk or not, and computerization further speeds this process, but be aware that human decision making has been put back into the underwriting of loans.
No longer will a decision of "yes" or "no" be solely determined by what the computer says, at least not completely. It now rests on a multitude of corresponding elements, all of which will be used to determine the promise that a loan will be paid back in a timely manner; and if it's paid back at all.
Underwriting parameters can be sorted into what's known as the Five C's and it would be in your client's best interest to understand these categories and know how they might affect their application for a mortgage. They are capacity, character, capital, collateral, and compliance.
Capacity is defined as the ability to make monthly payments. But it's more than just how much money a borrower brings home every month. It's also based on their occupation, their employment history, opportunities that they might have for the future, their age, as well as their education and training for the position they currently hold.
Stability and durability is a key factor here. Job changes are considered normal, and promotions are looked upon favorably. However, numerous job changes without advancement may be evidence of instability. Additionally, many job changes are not always necessarily frowned upon if their earnings remain steady.
Character is their willingness to make your monthly payments. This is where your clients have to demonstrate their ability to handle debt. As the underwriters go over their credit history, they will be looking for a pattern of timely payments based upon their agreed terms.
If they're always on time with their payments, they'll get favorable consideration, but if it shows that they've been inconsistent with their payments, the lender may want to know why. If upon further review a pattern of slow payments or judgments of nonpayment are discovered, then they'll probably have to provide detailed explanations.
Furthermore potential borrowers who continually increase their liabilities over time and then bail out by consolidating their debts or refinancing are seen as marginal. Also if the applicant has been involved in bankruptcy proceedings, liens or judgments or has willingly given up a house to a former lender, any future lender will want to be sure that the borrower has recovered by demonstrating over a period of time that they are capable of managing their finances.
Capital is their liquid assets. It's not only the cash that they have to use on a down payment as well as the required closing costs; it's also the reserves they have to make the initial payments or future payments if their income is interrupted by a job loss or a long illness.
If your client has enough cash for a down payment of 25% or 30% of the purchase price, then lucky for them because most lenders will approve a loan without too much checking. And of course, the more money they have in the deal the better.
It's not just the amount of cash that's important, but its origin. If your client borrows the down payment, then their equity is zero and therefore it's easier for them to walk away when something goes wrong particularly if they have little or nothing invested in the property.
Collateral is the value of the property they want to buy. An appraiser will evaluate the house your client is interested in to be sure that it can be sold for the amount they are borrowing in case they fail to make their payments.
Compliance is the last step. This is where the underwriter will make sure that the loan meets the lender's qualification standards.
For instance, it might be required that the property be an owner-occupied, single-family dwelling. That means that they don't want to lend to someone who is going to use it as an investment property such as a rental.
On the bright side, even if the loan falls outside one lender's conditions, it may meet another's. Furthermore, for a higher rate or different terms, the lender might grant the loan anyway.
Very few loan applications are slam dunks and most don't even fall within all the parameters defined by the lender's guidelines. When that happens, underwriters are instructed to look for "compensating factors" that will help offset a borrower's shortcomings.
Basically, the underwriter's job isn't to eliminate risk, but rather to evaluate the risk and to see whether it's acceptable and then prices it appropriately.