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Chapter 3. Underwriting

┠What is underwriting and how does it affect my loan?

┠What is my credit history?

┠Why do so many people have bad credit histories?

┠What kind of credit card user am I?

┠How do I find my credit history?

┠What is my credit score?

┠How do lenders use my credit score?

┠How can I improve my credit score?

┠What if I am not ready to get a mortgage right now?

┠What are income-to-debt ratios?

┠How can I improve my income-to-debt ratio?

┠Should I consolidate my debts?

┠How does the property itself figure into the mortgage formula?

┠What is a loan-to-value ratio?

┠How will an appraisal affect my down payment?

┠What is private mortgage insurance (PMI)?

┠Can I use a gift to pay for my down payment?

┠Can I use a gift from a stranger to make my down payment?

What is underwriting and how does it affect my loan?

When you apply for a mortgage loan, the success of your application depends on underwriting. Underwriting is the process used to decide whether to accept or reject a loan application. It is also used to qualify a borrower for a loan program. Qualifying for a loan is not an all-or-nothing scenario. A borrower may be rejected for the least expensive loan, but approved for a higher-risk, more expensive loan.

There has been a major change in the underwriting process in the past decade. Today, fewer and fewer people do the actual underwriting — instead, it is done by computers. This is called automated underwriting. As the name implies, a machine (rather than a person) does the work, and approves or rejects the application. Somewhat surprisingly, this has been a major benefit to many borrowers. It turns out that it is much tougher to get approved by a person than by a machine. The computer has been programmed in most instances to be much more forgiving for problems with credit, income, and debt than were the human underwriters. And, the computer does not worry about losing its job if it approves too many bad loans.

Regardless of whether a person or computer is actually doing the underwriting, there are three major factors that are considered in the underwriting process:

1. credit history;

2. income-to-debt comparison; and,

3. property value-to-loan comparison (down payment).

What is my credit history?

The term credit history merely refers to how you have managed your credit and debt over a period of time. It looks at how you have financed purchases, as well as how you made your payments on the amounts financed in terms of the amount paid and whether or not the payments were made on time. It is used by lenders to evaluate how you will handle future loans. They look at your past to predict your future.

A bad credit history has become an increasing problem. There are two basic reasons for this. First, it has become very easy to get credit. You are probably inundated every day with solicitations from credit card companies. College students can now easily get credit cards without any work history. Auto dealers advertise that they will sell a car to people with no credit history or a bad credit history. This allows many people to receive credit who cannot handle it well. The inevitable result is a failure to pay the debt on time or at all.

The second reason is that these loose lending practices have caused many people to believe that paying bills on time is not very important. Much of this comes from advertising. Companies, even some dealing with mortgages, say things like, “Bad credit shows that you are only human." Since credit is often easy to obtain — even with a poor credit history — paying on time does not seem to be very important.

But when it comes time to try to buy a house, a good credit history is a major factor in qualifying for a mortgage. To some lenders, it is the most important factor, even over your income-to-debt ratio. For example, many retirees are able to get loans that their income does not seem to support. This is because they have excellent credit. The lender believes that they will budget properly and repay the loan on time.

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