Capacity – The First C of Mortgage Underwriting

The mortgage underwriting process has become stringent post subprime loan crisis. The underwriter looks in detail in every aspect of your financial life, seeking explanations of everything that might cause you to miss a payment in future.

The ability to make mortgage payments on time is known as capacity, which can be vital for a loan approval. A borrower’s capacity is dependent on assets and the remainder of the income she or he is left with after paying residential costs, debts and other liabilities.

Financial Analysis

Prior to considering applying for a mortgage, you must analyze your current financial conditions. You may want to do an affordability analysis to see if you can really afford homeownership. A what-if analysis can help you determine the rate, principal amount and monthly payment.

A cost-benefit analysis also becomes necessary, especially when you are buying a second home or an investment property. An understanding of the basic terms, such as assets, liabilities, income and expenses, would also be necessary.

What are the different ways of doing financial analysis?

Debt-to-Income Ratio

A debt-to-income ratio is nothing but a comparison of the borrower’s gross income and expenses. It can be of two types.

  • Front End Ratio: This takes into account housing expenses only (mortgage payment or rental payment).
  • Back End Ratio: This takes into account housing as well as non-housing debts and expenses, such as mortgage, car loans and other consumer loans.

What are the maximum limits of debt-to-income ratio to qualify for a mortgage?

Capital or Cash Reserves

Your lender may or may not require a cash reserve, but it is often a good idea to have a cash amount in reserve to meet unexpected financial circumstances. Note that this amount is in addition to what you need for down payment and closing costs.

Cash reserves should ideally be held in a savings or checking account. Besides, a borrower may have 401(k) or IRA accounts also. Capital reserves, on the other hand, are less liquefiable, but can help borrowers in many other ways. These may include investments and assets.

What are the different types of assets?

Compensating Factors

There may be some factors other than the traditional ones that show your ability to repay a loan. These may include employment, rent and utility payment history, and are known as compensating factors. For example, a borrower with a poor credit score might qualify for loan if she or he can afford to put down 50% of the purchase price. Some of the known compensating factors include debt-to-income ratio, cash reserves, and the length of employment at the same place.

Updated on: March 28th, 2015 by Marlon Brown

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