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In honor of college basketball’s annual “Big Dance” held in March in which approximately 68 men’s teams compete for the NCAA Championship and ultimately boils down to the “Final Four.” It is a good time to reflect on the Four C’s of Single Family loan underwriting. They are Capacity, Credit, Cash and Collateral.
Outlined below is a brief description of each of these categories as well as an example of a frequent “Finding” relative to each one cited by the GSEs and HUD/FHA staff when reviewing post-closing loan files.
Capacity – this category comprises the analysis of the Borrower’s housing and debt ratios. On a manually underwritten loan transaction, the typical front-end ratio (payment of Principal & Interest, taxes, insurance and HOA fees) divided by gross monthly income should not exceed 28% (on conventional loans) and 31% (on FHA loan transactions). The back-end ratio which includes recurring debt obligations in addition to the mortgage payment calculation from the front-end ratio should not exceed 36% (on conventional loans) and 43% (on FHA loans).
However, the majority of loan transactions these days are processed via an Automated Underwriting System (AUS) in which case the ratios are not as important if the transaction receives an Approve (or Accept)/Eligible rating. One of the most recurring underwriting deficiencies cited for Capacity is that the Borrower’s gross monthly income was overstated based on an analysis of the Borrower’s YTD earnings vs his/her hourly rate. It is important to note that, despite receiving an Approve/Eligible rating, the integrity of the data that went into the AUS rating must be validated.
Credit – on AUS cases, the Borrower’s credit history is analyzed by the AUS system. Credit Reports are obtained and the Borrower’s credit score is determined. The higher the credit score – the lower the overall risk to the lender and insurer. One of the recurring problems are debts that are undisclosed and not taken into consideration by the credit report and AUS. Underwriters should carefully review documents contained in the loan file that may indicate there are undisclosed debts (i.e. payslips or bank statements that reflect a loan to the borrower which is not disclosed on the Loan Application or on the credit report).
Cash – this references the cash (or assets) that the Borrower has at the time of closing and the amount of cash reserves after closing. The more reserves a Borrower has after closing – the less risk to the lender and insurer. Sources of large deposits reflected on bank statements and funds for reserves need to be properly documented as to how these funds were obtained.
Collateral – the appraisal of the subject property that serves as collateral for the loan is important as the maximum mortgage amount sought by the Borrower is based on the fair market value of the property. The selection of the comparable sales and the adjustments made by the appraiser to each of these sales is a source of concern when underwriting the loan transaction.
Loading ...In my opinion, all four C’s are very important but if the appraisal reveals a problem with the property’s condition or if the mortgage amount requested is much higher than the fair market value of the property – all bets are OFF!
No sense proceeding with the loan application if the property presents an unacceptable risk or if the Borrower does not have sufficient assets to cover the difference between the Sales Price and maximum allowable mortgage amount. So, my answer is “Collateral” (I guess I will have to disclose that I have a Certified General Appraiser’s license – so I may be biased).
Finally – speaking of the Final Four – I have to add that I am a Villanova University graduate. So, I need to conclude by saying Let’s Go Wildcats! (sorry Oklahoma fans).
