Residential Lending Basics
Here’s a quick primer on residential lending, and why someone should or shouldn’t qualify for a loan.
There are three main facets to a good underwriting decision. One is credit history, the second is employment/income, the third is down payment/assets.
Credit History
Credit is scored on an alphabetical grade scale with A credit being very good with maybe a late payment or two over the past few years, with those late payments being explained by a written letter. B + C credit will have multiple credit dings, maybe some collections, but no real huge credit issues. D credit is going to have major lates, including possible mortgage lates. A credit gets the prime, advertised interest rates, B+C have to pay a premium in interest rates, D is what is consider sub-prime. Credit factors can be compensated for/overcome in residential lending if income is high, or there is a large downpayment or equity in a home.
Many lenders will use a FICO credit score to determine creditworthiness, in a FICO score ,720 or more is good, 620 or below is getting in the sub-prime category.
Employment/Income
The last two years of employment is the most important in a lending decision. Two years with the same company, or in similar industries, with a steadily rising income can predict a probability that the borrower will continue with steady employment, allowing them to make their housing payment on time. The general rule of thumb is that a borrower shouldn’t be paying more than 33% of their gross (before taxes) income on housing, including their principal and interest on the loan, property taxes, and hazard insurance on the home.
Down Payment/Assets
The traditional standard is a borrower should be putting 20% down payment on a home. Homeownership rates have increased by relaxing those standards, mortgage insurance(MI) protecting the lender for losses they may suffer above that 80% Loan To Value point started the ball rolling, lender programs offering both a first and second loan totalling sometimes more than the value of the property continued the low down payment phenomenon. Typically, a borrower should have at least two or three months worth of housing payments in cash at a bank or somewhere it can be quickly obtained if there is an emergency requiring those funds to keep a home loan current.
A solid borrower should have good credit, stable employment/work history and a little bit of financial cushion in case of life issues.
A slightly more risky borrower will have issues with one of those three, but have other strong characteristics.
A risky borrower is one that doesn’t really have any strength in any of those facets.