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© Cengage Learning 1
CHAPTER 13
UNDERWRITING
THE RESIDENTIAL MORTGAGE LOAN
OBJECTIVES OF CHAPTER
Upon successful completion of this chapter, students should be able
to:
State the purpose of underwriting guidelines
Explain why the initial interview is so important to the
underwriting process
Identify the different types of risks analyzed in the underwriting
process and the effect on pricing
Calculate the different kinds of ratios commonly used in
underwriting: loan-to-value, housing expense, and total debt
List the types of information analyzed by the underwriter in
each of these areas: applicant’s financial capability; applicant’s
credit history; and the collateral (real estate) securing the
mortgage
Compare Automated Underwriting Systems to Manual
Comprehensive Risk Assessment Guidelines
Understand the issues behind discrimination in mortgage
lending and what the Federal Government has done about this
activity
© Cengage Learning 2
I. Introduction
A. Definition of underwriting
B. Three stages of underwriting
C. No uniform formulas
II. Underwriting by a Mortgage Lender
A. Analyzing Risk
III. Underwriting Guidelines
A. Use of Technology for Underwriting
B. Risk-based Pricing Adjustments
C. Conflicting Objectives?
IV. Underwriting Areas of Review
A. Prequalification of Applicants
B. Loan Policy and Eligibility Issues
V. Loan-to-Value Ratios
A. Combined LTV
VI. Capacity
A. Down Payment (Equity)
B. Income of Applicant(s)
C. IRS and Sources of Income
D. Housing Ratio
E. Total Debt Ratio
Teaching Tips
What kinds of risk do mortgage underwriters analyze?
What are the five possible stages of underwriting for a
mortgage loan?
What are risk-based pricing adjustments? Discuss the
benefits and drawbacks for their use.
Which risk factors and underwriting stages do you think
contributed to the recent collapse of the industry? What
are the five C’s the underwriter uses to evaluate a loan?
Which factor do you think carries the most weight?
Describe the different LTV-based calculations.
What is included in the total debt ratio? What is not and
why?
Can anyone suggest a balance between manual and
automated underwriting and how would that work?
© Cengage Learning 3
VII. Credit
A. Credit History
B. Use of Debt
C. Repayment History
D. Minor Delinquency
E. Situational Delinquency
F. Chronic Delinquency
G. Bankruptcy
H. Past Foreclosures or Deed in Lieu
I. Credit Scores
J. Collateral
K. Property and Appraisal Standards
L. Underwriter’s Review of Appraisal
VIII. Automated Underwriting Systems
IX. Standard vs. Limited/Streamlined Documentations
A. Comprehensive Risk Assessment
B. Underwriting Worksheet Summary
X. The Underwriting Decision
XI. Managing the Underwriting Function
A. Fraud and Quality Control
B. AUS and Comprehensive Risk Assessments
XII. Underwriting Guidelines and Loan Application
Register
XIII. Discrimination and the Federal Government
Describe the different categories of delinquency
and their relative importance in evaluating the
applicant’s willingness to repay.
Discuss the strengths and weaknesses of the
credit score.
What do underwriters look for when evaluating
the collateral?
Describe the comprehensive risk assessment
process.
What is meant by the phrase, “underwriting is an
art and not a science?”
Do you think automated underwriting systems
avoid foreclosure or loss better than manual
underwriting?
Should lenders be required to use a third party
agency for quality control checks?
Discuss how discriminatory lending practices
have changed over the years for residential
mortgage lending.
© Cengage Learning 4
SUGGESTED TRUE/FALSE QUIZ
1. Underwriting is the process of analyzing risk
2. In underwriting residential mortgage loans, the lender should
follow a strict formula.
3. Uniform underwriting guidelines exist for all residential
mortgage loans.
4. Lenders should have a written underwriting and loan policy to
review with potential borrowers.
5. Long-term debt is defined as monthly obligations extending
more than three years into the future.
6. Acceptable ratios for housing expenses and long term debt for
conventional and FHA loans are both based on gross monthly
income.
7.. One way of verifying a self-employed applicant’s income is to
review federal income tax returns from the previous two years.
8. The appraisal establishes the adequacy of the security as well as
the loan-to-value ratio.
9. The appraiser in estimating property value considers building
codes and zoning ordinances.
© Cengage Learning 5
10. To reject an application because of the property’s location and
neighborhood is discriminatory.
11. Income from a part-time job may not be considered when
evaluating the financial capability of the borrower
12. Lenders have 30 days from the date of application in which to
notify the applicant whether the loan request has been approved
or rejected.
13. Attitude toward credit needs to be considered only when
the applicant’s income does not qualify
MULTIPLE CHOICE QUESTIONS. More than one answer may
be correct – select all correct answers. (Correct answers are
italicized.)
1. Today most residential mortgage loan underwriting decisions
are made by:
d. Loan officers
2. Where are the underwriting guidelines of the secondary
© Cengage Learning 6
mortgage market delineated?
a. Statutes of a particular state
3. Which “C” is NOT one of the “4 Cs” of evaluating a mortgage
application?
a. Credit
4. According to industry studies, this item is considered the best
predictor of delinquency.
a. Amount of income
5. Credit scores are very important in residential mortgage lending
today. What score is the recommended score for streamline or
minimal review?
a. 400
© Cengage Learning 7
SUGGESTED SHORT ESSAY QUESTIONS
1. Identify the types of risks present in residential mortgage lending and
which of these does an underwriter evaluate?
ANSWER: credit, collateral, default, fraud, compliance, interest rate,
price and market, liquidity, secondary market, portfolio, and
2. How do underwriting guidelines mitigate the risks in mortgage
lending?
ANSWER: The underwriting analysis quantifies the risk factors
present and measures these against other strengths in the file to
3. What are the pros and cons of Automated Underwriting Systems?
© Cengage Learning 8
ANSWER: Pros: AUS provide the potential for enormous cost
savings and faster approval and closings. As they develop, the
capacities and services of these AUS go way beyond providing a
4. How do the Loan-To-Value (LTV) and Combined LTV (CLTV)
affect the way the underwriter reviews a mortgage application? Why
are these so important?
ANSWER: Industry studies find the LTV is the most significant risk
factor affecting loan delinquency, default, and loss. It is arguably the
most important underwriting ratio and has the greatest single impact
© Cengage Learning 9
5. What compensating factors might offset a total debt ratio that exceeds
a lender’s guideline?
ANSWER: Higher ratios above 36 percent may be justified by
mitigating factors, such as demonstrated ability of an applicant to
to accumulate savings and maintain a good credit rating, large net
6. What are credit scores? How does the secondary market use credit
scores and how are they different from mortgage scores?
ANSWER: A credit score is a numeric rating of an applicants’ use of
debt and credit repayment history. Although the use of credit scores
© Cengage Learning 10
7. In what ways does a “Comprehensive Risk Assessment” differ from
other underwriting reviews?
ANSWER: “Comprehensive Risk Assessment” is similar to the risk
analysis format described in this chapter, but focuses only on default
risk. The assessment guidelines are based on the analysis of millions
