Loan Approval Hinges on Several Factors

WASHINGTON â€”  During a media seminar years ago, a small group of real estate writers was given 30 minutes to pore over a hypothetical mortgage application and decide whether to approve the loan. We didn’t do very well.

The majority of us approved the loan, but for all the wrong reasons. And if we learned anything from the exercise, it is that analyzing a potential borrower to determine if he stacks up as a good risk is an art, not a science.

Nowadays, though, mortgage applicants are underwritten more by computers than by human beings, so the process is far more scientific than it used to be.

But whether your fate is determined by man or machine, the rules are still essentially the same. Only they aren’t rules at all; they’re guidelines.

Moreover, a decision usually doesn’t hinge on any one factor. Rather, it rests on a multitude of interrelated elements, all of which must be weighed to determine the probability that the loan will be repaid in a timely fashion; and, if it’s not paid back, whether the property is of sufficient value to recover the lender’s investment.

Generally, underwriting parameters can be sorted into what Dottie Viti of GE Capital Mortgage Insurance in Charlotte calls the “Five Cs�: capacity, character, capital, collateral and compliance:

* Capacity. This is defined as the ability to make monthly payments. But it’s more than just how much money the potential borrower earns every month. It’s also his occupation, employment history, opportunities for the future, age, educational background and training for the position he holds.

Key factors are stability and durability. In other words, it’s best not only to demonstrate consistency but also to be in a field in which workers are in high demand and where advancement is possible, if not probable.

Job changes are seen as normal, and frequent movement up the ladder is looked upon favorably. But numerous changes without advancement or from one line of work to another may be evidence of instability. Still, job-hopping is not necessarily frowned upon if earnings remain stable.

If you’re self-employed, the stability of your business must be established with profit-and-loss statements, balance sheets, income statements and tax returns for the two most recent fiscal years.

If the business is less than 2 years old, a more subjective review will consider your training and experience in the field, your working capital and other pertinent factors.

Secondary income such as bonuses, commissions, overtime or part-time work is considered steady income if it is typical for your occupation, can be substantiated and will probably continue.

Alimony and child support are stable income to the extent they are likely to continue.

* Character. This is your willingness to make monthly payments.

Here you must demonstrate your ability to handle debt. In going over your credit history, underwriters won’t be looking for isolated problems as much as for a pattern of timely payments according to the agreed-upon terms.

If your record shows you’re always on time, you’ll get favorable consideration. But if it shows that you’ve encountered difficulties meeting your obligations, the lender may want to know why. And if it indicates a pattern of slow payment or reveals suits and judgments for nonpayment, you’ll have to provide detailed explanations.

Would-be borrowers who continually increase their liabilities over time and then bail out by refinancing or consolidating their debts are seen as marginal.

And if the applicant has been subject to bankruptcy proceedings, liens or judgments, or has voluntarily given up a house to a former lender, any subsequent lender will want to be sure the borrower has recovered by demonstrating over time that he is capable of managing his financial affairs.

* Capital. This is your liquid assets. This isn’t only the cash you have on hand to make the down payment and pay all the required closing costs. That’s a big part of it, yes, but it’s also the reserves you have to make the initial payments or later payments if there is an interruption in your income.

If you have a big wad of money for a down payment--say 25% or 30% of the purchase price--most lenders will throw caution to the wind and approve a loan without doing too much checking. And the more money you have in the deal, the better.

“Equity motivates,� said John Hemschoot of Freddie Mac, a major supplier of funds for mortgages. “In fact, there is no stronger motivator (for a borrower to make his house payments above all else) than plunking down a large amount of his own cash.�

At the same time, though, if you are attempting to buy more house than you apparently can afford, said Viti of GE Capital, you’ll be subject to a more thorough inquiry than normal.

Either way, though, it’s not just the amount that’s important, it’s also the origin of the funds.

If you borrow the down payment, your equity in the deal is zero. And it’s easier to walk away when something goes wrong if you have little or nothing invested in the property.

Lenders like to see “a regular pattern of savings,� Viti said. But if you don’t have enough cash, they will accept gifts of cash or grants that you don’t have to pay back.

Borrowing the down payment is frowned upon, though, so if the underwriter finds a recent and large deposit in your account, or if the average balance has been less in the last few months than it is when you apply, he’s going to be concerned.

* Collateral. This is the value of the property you want to buy. Here, you’ll pay for an appraiser of the lender’s choice to evaluate the house to be sure that it can be sold for the amount you are borrowing in case you fail to make your payments.

* Compliance. This is the final step. Here, the underwriter will make sure the loan meets the lender’s eligibility standards. For example, the property might have to be an owner-occupied, single-family dwelling. More stringent rules might apply to an investment property or a condominium apartment, both of which are considered more risky.

Even if the loan falls outside one lender’s standards, it may meet another’s. Also, for a higher rate or different terms, the lender might make the loan anyway.

Lew Sichelman is a syndicated real estate columnist. He can be contacted via e-mail at LS[email protected]. Distributed by United Feature Syndicate.

No Applicant Meets Every Criterion

Few loan applications are cut and dried, or, as lenders call them, “pretty.�

In fact, “most don’t fall within all the parameters� defined in a lender’s guidelines, said Dottie Viti of GE Capital Mortgage Insurance in Charlotte, N.C.

When they don’t, underwriters are instructed to look for what are known as “compensating factors� that offset a borrower’s shortcomings. “The underwriter’s job isn’t to eliminate risk,� says Viti. “It’s to evaluate the risk to see if it’s acceptable.�