Click to Call 760-208-1739

What Lenders Need

What Lenders Need

Lenders look for the borrower’s ability and willingness to repay debt. They speak of the three Cs of credit: capacity, character, and collateral.

Lenders use different combinations of the three Cs to reach their decisions. Some set unusually high standards while others simply do not make certain kinds of loans. Lenders also use different rating systems. Some strictly rely on their own instinct and experience. Others use a credit scoring or statistical system to predict whether the borrower is a good credit risk. They assign a certain number of points to each of the various characteristics that have been proven to be reliable signs that a borrower will pay his or her debts. Then they rate the borrower on this scale.

Once the components of a mortgage application have been analyzed, a lender must determine whether the risks associated with capacity, character, and collateral combine to make an investment-quality mortgage. The probability that the borrower will default grows when there are multiple risk factors present. This is known as layering risk. Layering also can appear within one of the three Cs. In terms of capacity, for example, a borrower may possess both a high debt-to-income ratio and minimal reserves.

To complicate the lending decision further, an underwriter must analyze not only the layers of risk, but must identify the strengths that offset those risks. Different lenders may reach different conclusions based on the same set of facts. One may find the applicant an acceptable risk, but another may deny the loan.


A borrower’s financial ability to repay a mortgage is one of the three determining factors of credit. In other words, can the borrower repay the debt? In general, lenders assess capacity by using the debt-to-income ratios. This expresses the percentage of income necessary to cover monthly debt, including the mortgage payment. Lenders ask for employment information such as the borrower’s occupation, how long the borrower has worked for his or her current employer, and the borrower’s earnings. Lenders may also consider the borrowers’ savings or cash reserves as income and use them to assess capacity. Lenders want to know the borrower’s expenses, how many dependents there are, if the borrower pays alimony or child support, and the amount of any other obligations.


Lenders ask if the borrower will repay the debt. Lenders look at the borrower’s credit history, including the amount of money owed, the frequency of borrowing, the timeliness of bill payment, and a pattern of living within one’s means.

The credit information compiled by national credit bureaus reveals a borrower’s history of handling credit. A credit bureau is an agency that collects and maintains up-to-date credit and public record information about consumers. A credit bureau may also be called a credit-reporting agency.

In addition to detailed financial information, credit bureaus give lenders a numerical score or a credit summary that projects a borrower’s expected credit performance. Credit bureau scores are based on the statistical relationship between information in a borrower’s credit files and his or her repayment practices. These scores accurately summarize a borrower’s likelihood of repayment. A FICO® score is one example of a credit bureau score. FICO® scores range in value from about 300, which denotes the highest risk, to about 850, which indicates the lowest risk. Another example of a credit bureau score is the MDS bankruptcy score, for which a lower score indicates lower risk. Lenders look for signs of stability such as how long the borrower has lived at the present address, if he or she owns or rents the home, and the length of current employment.

Credit files also document the number and nature of recent credit inquiries and information from public records, such as declarations of bankruptcy and unpaid judgments. Because there is such an assortment of information the lender must consider, it is difficult to make an accurate assessment of a borrower’s credit profile.



When money is loaned for financing real property, the borrower gives the promise to repay the loan and gives collateral as security for the loan. Collateral is something of value given as security for a debt. This is because the lender wants to be fully protected in case the borrower fails to repay the debt. Borrowers have many types of assets that may be used to back up or secure a loan. These assets include any resources other than income the borrower has for repaying debt, such as savings, investments, or real property.



Upon receiving the loan package, the underwriter analyzes the risk factors associated with the borrower and the property before making the loan. Underwriting is the practice of analyzing the degree of risk involved in a real estate loan. The underwriter determines whether the borrower has the ability and willingness to repay the debt and if the property to be pledged as collateral is adequate security for the debt.

The underwriter also examines the loan package to see if it conforms to the guidelines for selling in the secondary mortgage market or directly to another permanent investor. In any case, the loan must be attractive to an investor from the perspectives of risk and profitability. If any part of the loan process is poorly done (the processing or underwriting is subpar, for example), the lender might find it difficult to sell the loan. In addition, if the borrower defaults on a carelessly underwritten loan, the loss to the real estate lender can be considerable. For example, if the appraisal is too high and the borrower defaults, the lender may sustain a loss. The probability of a loss is higher when the house is appraised at more than its actual worth because it is likely that the property will sell for less than the loan amount plus other costs of default.


Underwriting Guidelines

Guidelines are a set of general principles or instructions used to direct an action. Underwriting guidelines are principles lenders use to evaluate the risk of making real estate loans. The guidelines are just that—guidelines. They are flexible and vary according to loan program. If a borrower makes a small down payment or has marginal

credit, the guidelines are more rigid. If a borrower makes a larger down payment or has sterling credit, the guidelines are less rigid. Lenders who expect to sell their loans in the secondary market use underwriting guidelines that adhere to Fannie Mae and/or Freddie Mac standards. During the underwriting process, underwriters use loan-to-value ratios and debt-to-income ratios, among other economic considerations, to qualify the borrower.


Loan-to-Value Ratios

To calculate the payment, the lender begins by asking for the loan amount. The maximum loan amount is determined by the value of the property and the borrower’s personal financial condition. To estimate the value of the property, the lender asks a real estate appraiser to give an opinion about its value.

Real estate appraisers are regulated by state law and must meet federal appraisal guidelines. The appraiser is a neutral party who appraises property without bias toward lender or borrower. The appraiser’s opinion can be an important factor in determining if the borrower qualifies for the loan size he or she wants.

Lenders usually lend borrowers up to a certain percentage of the appraised value of the property, such as 80 or 90%, and expect the down payment to cover the difference. If the appraisal is below the asking price of the home, the down payment the borrower plans to make and the amount the lender is willing to lend may not be enough to cover the purchase price. In that case, the lender may suggest a larger down payment to make up the difference between the price of the house and its appraised value.

Evaluating the loan-to-value ratio (LTV) is probably the most important aspect of the underwriting process. The loan-to-value ratio (LTV) is the relationship between the loan (amount borrowed) and the value of the property.

For example, if the property in question is valued at $100,000 and the loan amount requested is $80,000, the loan-to-value ratio is 80%. The down payment from the borrower is equal to the difference between the amount borrowed and the value of the property. The down payment is the initial equity the borrower has in the property.

There is a distinct relationship between borrower equity and loan default. Mortgage research has shown that a borrower with a significant financial stake in the property is less likely to default. In one 5-year period for loans purchased by Freddie Mac, borrowers who put down 5% to 9% were 5 times more likely to enter foreclosure than those who made down payments of 20% or more.

Example: Freddie Mac found that borrowers with both smaller down payments (collateral) and riskier credit profiles experience a dramatically higher probability of default than borrowers with only one of these two risk factors present.

Larger down payments lower the LTV ratio on the loan and reduce risk to the lender. The risk to the lender is the risk that the borrower will default on loan payments, thereby causing the property to go into foreclosure. In that event, the lender either receives the property at the foreclosure sale or receives a deficient amount at the sale. A deficiency occurs when the amount for which the property sells is less than the total amount due to the lender. Neither is desirable from the point of view of the lender or investor. Therefore, it is important for the underwriter to determine if the LTV falls within the guidelines for that particular loan.


Down Payment Guidelines

Most lenders require the borrower to pay some kind of down payment to show that he or she does have a monetary or equitable interest in the property. The belief is that the borrower protects his or her interest to a greater degree if there is some personal money invested in the purchase. The loan processor has already verified the down payment during loan processing by checking the borrower’s bank account to confirm the money is currently on deposit. As mentioned previously, the Verification of Deposit (VOD) is the documentation that establishes the existence and history of funds to be used for a down payment and determines how long the funds have been in the account. The loan processor determines the length of time funds have been on deposit to make sure the applicant has not recently borrowed the money from a friend or relative. If borrowed money is deposited, the lender’s concern is that the borrower is not investing any personal money in the purchase. Lenders verify that funds have been deposited with the institution for at least 3 months.


Debt-to-Income Ratios

A lender calculates the maximum loan amount for which a borrower qualifies. To determine the borrower’s ability to repay the loan, the underwriter uses debt-to-income ratios to calculate the risk that the borrower will default. The debt-to-income ratio (DTI) is simply the percentage of a borrower’s monthly gross income that is used to pay his or her monthly debts.


Common DTI Ratios

  • Conforming loans use 28% front ratio and 36% back ratio (28/36)
  • FHA uses 31% front ratio and 43% back ratio (31/43)
  • VA only uses back ratio of 41% as a guideline
  • Non-conforming loans have very flexible DTI ratios

The front ratio is the percentage of the borrower’s monthly gross income (before taxes) that is used to pay housing costs, including principal, interest, taxes, and insurance (PITI). When applicable, it also includes mortgage insurance and homeowners’ association fees.

The back ratio is the total monthly PITI and consumer debt divided by the gross monthly income. Consumer debt can be car payments, credit card debt, installment loans, and similar expenses. Auto or life insurance is not considered a debt.

When the maximum front-end ratio is 28%, it means that borrowers’ housing costs should not be more than 28% of their monthly income. When the maximum back-end ratio is 36%, it means that total debt (housing and consumer) should not be more than 36% of the gross monthly income.

There is a distinct relationship between total-debt-to-income ratios and foreclosure rates.

Example: Based on the purchases Freddie Mac made in 1994, borrowers with total-debt levels greater than 36% of their income were twice as likely to enter foreclosure as those with ratios below 30%.

While capacity is an important underwriting component, debt-to-income ratios generally are less powerful predictors of loan performance than other factors. The Relative Foreclosure Rate chart shows the relationship between debt-to-income ratios and foreclosure rates among borrowers.

FHA guidelines state that a 31/43 qualifying ratio is acceptable. VA guidelines do not have a front ratio at all, but the guideline for the back ratio is 41.

Example: If Borrower Brenda makes $5,000 a month, to meet 31/43 qualifying ratio guidelines, her maximum monthly housing cost should be around $1,550. Including Brenda’s consumer debt, her monthly housing and credit expenditures should not exceed about $2,150.

Lenders who do not provide FHA or VA loans commonly use the guideline that suggests the total of all debt should not be more than 36% of the borrower’s gross monthly income. However, the lender may consider other factors and allow a higher debt-to-income ratio. These factors include a larger down payment than normal, a large amount of cash in savings, a large net worth, or an especially solid credit rating.

Underwriting the Borrower

The risk factors associated with the borrower include employment history, income, assets, credit history, and credit score. The amount of income indicates the borrower’s ability to repay the loan, whereas the credit history reflects the borrower’s willingness to repay the loan.

The borrower must be prepared to provide certain documentation.

Required Documentation

  • Income – W2s for prior years and year-to-date pay stubs
  • Federal income tax returns – Form 1040 and other related schedules
  • Current debts – account number, outstanding balance, and creditor’s address for each
  • Purchase contract for the desired property

Employment & Income

The lender should consider and evaluate acceptable employment and income when underwriting loans. The borrower should have at least 2 years of stable and continuing employment. The loan package includes a Verification of Employment (VOE) that the borrower must complete and sign. Lenders use the Verification of Employment (VOE) form as part of the process of documenting the borrower’s employment history.

VOE Information the Underwriter Checks

  • Probability of continued employment with the same employer
  • Consistency between actual dates of employment and those on the application
  • Presence of employer’s signature
  • Consistency between salary/wages and the amount on the application
  • Minimum of 2 years of employment with current employer (if not, a VOE from the former employer is requested)
  • Likelihood that overtime/bonus income will continue


In addition to employment income, lenders review any investment income, notes receivable, rental income, pension and retirement income, social security, disability income, interest from bonds and savings accounts, royalties, unemployment benefits, and verified income from public assistance programs if evidence indicates it will continue for 3 years or more. Certain sources of income are not considered stable and reliable unless they continue for 2 years or more. These may include part-time employment, income from the care of any foster child(ren), worker’s compensation income, and automobile or similar allowances.

Frequent Job Changes. It is possible to establish stable, reliable income without having worked for just one employer. Many borrowers change employers because they are seeking higher wages or better employee benefits. Sometimes borrowers are simply going where there is available work.

Income from Overtime, Part-Time Employment, and Bonuses. Often people take part-time jobs to supplement their income. Lenders must review such income for probable continuance and try to ascertain whether the part-time employment is reasonable and sustainable. Borrowers should show a 2-year history, but the lender may consider allowing 1 year for an otherwise strong borrower.

Periods of Unemployment. In parts of the country, it is not unusual for some individuals to work for certain parts of the year and draw unemployment for the remainder of the year (such as field workers). A period or periods of unemployment will not automatically be considered unfavorably provided the unemployment is regular and seasonal or is a limited occurrence between jobs and the applicant received unemployment compensation during those periods. If the applicant has a history of such an income pattern, the lender may use unemployment compensation as well as income received during periods of employment when calculating an individual’s income for loan approval purposes.

Credit History

The lender is particularly interested in how likely the borrower is to repay the loan. The lender tries to determine not only if a borrower can but also if he or she will repay the loan. One of the most important elements that influence a borrower’s ability to obtain a good interest rate on a real estate loan is a borrower’s credit history.

The three major credit bureaus independently collect data and use the data to create consumer credit reports. A credit report is a document that lists an individual’s credit history. Lenders review the borrower’s credit report to see if the borrower has a credit history of meeting payments in a timely manner according to contract terms. Many lenders use a standardized credit report called the Residential Mortgage Credit Report.

Three Major Credit Bureaus

A credit report includes four categories of data that have been collected and reported to the credit bureaus. They are (1) personal information, (2) credit information, (3) public record information, and (4) inquiries. According to the Equal Credit Opportunity Act (ECOA), the credit report does not include certain factors such as gender, income, race, religion, marital status, and national origin.

The report should show the borrower’s credit patterns over the last 7 years and must be less than 90 days old. Credit reports should include credit information from two national credit bureaus, as well as information gathered from public records, such as judgments, divorces, tax liens, foreclosures, bankruptcies, or any other potentially damaging information that may indicate a credit risk. The credit report should include information on the borrower’s employment and reflect any credit inquiries made by any lender within the last 90 days.

When the underwriter analyzes the borrower’s credit, he or she reviews the overall pattern of credit behavior rather than isolated cases of slow payments. A period of financial difficulty does not disqualify the borrower if a good payment pattern has been maintained since then. Sometimes the lender will ask the borrower to write a letter of explanation for adverse items in his or her credit report.


Good Credit History

If the credit report shows a positive borrowing history, the underwriter considers it a good indication that the borrower is creditworthy. A lender may reject an application early in the underwriting process if the report shows that the borrower has a poor credit history.


Poor Credit History

Typical items that indicate a poor credit history include late mortgage payments, bankruptcy, collections, judgments, federal debts, and foreclosures. If the credit report shows a negative borrowing history, the borrower usually must reestablish credit.

Late Mortgage Payments. With some exceptions, acceptable credit is generally considered to be reestablished after the borrower has made satisfactory mortgage payments for 12 months after the date of the last derogatory credit item(s).

Bankruptcy. Bankruptcy creates particular concerns. Most lenders require that a minimum of 2 years elapse between the discharge date (not the filing date) of a Chapter 7 bankruptcy and the submission date of the loan application. The lender also requires a full explanation of the bankruptcy. Finally, the borrower must have reestablished good credit.

Most lenders consider a borrower who is still paying on a Chapter 13 bankruptcy if the payments to the court have been satisfactorily made and verified for a period of 1 year. In addition, the court trustee must give written approval to proceed. Again, a full explanation of the bankruptcy is required. Finally, the borrower must have reestablished good credit, qualify financially, and have good job stability.

Collections, Judgments, and Federal Debts. The borrower must pay off or make payment arrangements for outstanding collections, judgments, and/or federal debts before a loan can be approved. If a collection is minor in nature, it usually does not need to be paid off as a condition for loan approval. Judgments must be paid in full prior to closing. A borrower is not eligible for the loan if he or she is delinquent on any federal debt. This can include tax liens, student loans, and so forth. The borrower may be considered for loan approval if he or she has made payment arrangements that bring the borrower up to date. Account balances that were reduced by court judgment must be paid in full or subject to a repayment plan with a history of timely payments.

Foreclosure. A borrower, whose previous residence or other real property was foreclosed on or who had given a deed in lieu of foreclosure within the previous 2 years, is generally not eligible for a real estate loan. If the foreclosure was on a VA loan, the applicant may not have full entitlement available for the new loan.


No Credit History

In the area of credit, the lack of an established credit history should not curb loan approval. As provided in the credit standards, the borrower may use satisfactory payment history on items such as rent, utilities, phone bills, and other scheduled payments to establish a satisfactory credit history.


Credit Score

A credit rating is a formal evaluation given by credit bureaus of a borrower’s ability to handle new credit based on past performance. Typically, credit ratings are provided in the form of a credit score. A credit score is a statistical summary of the information contained in a consumer’s credit report. Credit scores are based on information derived from credit reports of consumers who have obtained credit in the past. These credit reports are evaluated to identify characteristics that predict the likelihood of debt repayment.

Credit scores consider both positive and negative information in a credit report. Late payments lower the score, but establishing or re-establishing a record of timely payments raises the score.


Credit Score’s Affect on Loans

Real estate lenders use credit scores as a significant factor in their decision-making process. Lenders commonly use the credit score to screen a potential borrower and often it becomes the compelling basis for loan approval. Lenders use credit scores to rank consumer risk and determine loan amounts.

The quality of the credit score also affects the interest rate the lender charges the borrower. Generally, the higher the credit score, the lower the payments. Borrowers with high credit scores are usually offered the lowest rates on loans. The lower the credit score, the less likely the lender is to extend credit. However, if the lender does extend credit, borrowers with low credit scores pay higher interest rates. The higher interest rate reflects the higher risk involved in making such a loan.

The higher the credit score, the lower the interest rate, and the lower the monthly payment. The following chart illustrates this concept for a $225,000, 30-year, and fixed-rate loan.

Credit Scores Affect the Interest Rates and Monthly Payments

FICO® score


Monthly payment*



















*Estimated average over the life of the loan. Payments may vary.

Although a variety of credit-scoring systems are available for use, the two most frequently used are FICO® and VantageScoreSM.

FICO® Score

The best-known type of credit score is the Fair Isaac or FICO® score, which is calculated by the Fair Isaac Corporation. FICO® scores run from 300 to 850 and are generated using complex statistical models. The models are based on computer analyses of millions of consumers’ credit histories.

A FICO® score only considers information in the consumer’s credit report. However, lenders look at many factors when making a credit decision, such as income, length of time at current job, and the kind of credit the borrower is requesting.


VantageScoreSM is the first score of its kind to leverage a consistent scoring methodology across all three credit bureaus to deliver highly predictive and easy to understand risk scores. The score range accommodates the natural A, B, C, D, and F grade levels and scales all scorecards consistently. The existence of leveled credit characteristics across all three national credit bureaus ensures that any score differences for the same borrower are attributable to content differences and not differences between the scoring algorithms used in various scoring systems.

Comparison of FICO® Score & VantageScoreSM

The following chart is a general guide to the characteristics of A, B, C, D, and F credit. These are typical of the requirements used by many lenders, but are not absolute grades. Lenders generally have similar but somewhat different specifications.



FICO® Score


A+ to A-
The best credit rating
Generally 700 and up
Home loans: 0 lates
Revolving Credit: 1 30-day late
Bankruptcy: 0 past 2–10 years
Debt ratio: 36–40%
LTV ratio: 95–100%

This credit score demands the best interest rate available.Generally 901 and up
Home loans: 0 lates
Revolving Credit: 1 30-day late
Bankruptcy: 0 past 2–10 years
Debt ratio: 36–40%
LTV ratio: 95–100%

This credit score demands the best interest rate available.B+ to B-
This grade generally signifies good creditScores from 660-699
Home loans: 2-3 30-day lates
Revolving Credit: 2-4 30-day lates
0 60-day lates
Bankruptcy: 2-4 years since discharge
Debt ratio: 45–50%
LTV ratio: 90–95%

This credit score generally carries a loan interest rate 1–2% higher than the current market rate.Scores from 801-900
Home loans: 2-3 30-day lates
Revolving Credit: 2-4 30-day lates
0 60-day lates
Bankruptcy: 2-4 years since discharge
Debt ratio: 45–50%
LTV ratio: 90–95%

This credit score generally carries a loan interest rate 1–2% higher than the current market rate.C+ to C-
Fair creditScores from 620-659
Home loans: 3-4 30-day lates
Revolving Credit: 4-6 30-day lates or
2-4 60-day lates
Bankruptcy: 1-2 years since discharge
Debt ratio: about 55%
LTV ratio: 80–90%

This credit score generally carries a loan interest rate 3–4% higher than the current market rate.Scores from 701-800
Home loans: 3-4 30-day lates
Revolving Credit: 4-6 30-day lates or
2-4 60-day lates
Bankruptcy: 1-2 years since discharge
Debt ratio: about 55%
LTV ratio: 80–90%

This credit score generally carries a loan interest rate 3–4% higher than the current market rate.D+ to D-
Overall poor credit historyScores from 580-619
Home loans: 2-6 30-day lates or
1-2 60-day lates with isolated 90-day lates
Revolving Credit: poor payment record and late payment pattern
Foreclosure: allowed, all unpaid judgments paid with loan proceeds
Employment: Must be stable
Debt ratio: about 60%
LTV ratio: 70–80%

This credit score results in borrowers paying the highest sub prime interest rates. However, if loan payments are made on time and the credit rating does not deteriorate any further, the borrower may be able to bring the rate down by refinancing after 1 yr.Scores from 601 to 700
Home loans: 2-6 30-day lates or
1-2 60-day lates with isolated 90-day lates
Revolving Credit: poor payment record and late payment pattern
Foreclosure: allowed, all unpaid judgments paid with loan proceeds
Employment: Must be stable
Debt ratio: about 60%

Practical Application:

Applying Borrower Underwriting Guidelines

Mike and Jan Hill, a young married couple, want to purchase a single-family detached home located at 652 Berry Street, Any City, Any County, USA. The sellers, Sam and Cindy Winter, have the home listed at $189,000. Fred and Jan put an offer to purchase the property for $180,000 with a 1% deposit, which the seller quickly accepts. The agreed upon closing date is June 30, 20xx.

Fred and Jan have a net combined income of $6,000 per month. Fred’s credit was marred by some delinquencies with credit cards during college, but he is on the path to raising his credit score. After college, Fred served in the armed forces as an officer and was able to pay off a good majority of his debt. As it stands, his current FICO® is 640 based on a tri-merged report from all the major credit bureaus. Jan was more fiscally responsible than Fred was and, as a result, has a stellar credit rating of 710.

Currently, their total credit card expenses equal $200 per month. Fred and Jan both commute to work using their own separate vehicles, both of which still have monthly payments. The combined monthly payment for both vehicles is $500. Jan has a school loan amounting to $100 per month that she took out while she attended Best University. When Fred and Jan got married a year ago, the couple received cash gifts that totaled $25,000, which they put into an interest bearing account. Since then, they have contributed 10% of their monthly income and any other extra cash they received throughout the past year (bonuses, part-time work, etc.) to the account. The total savings in their account is now $40,000. Fred and Jan only want to put 5% down so that they have extra cash on hand as reserve funds.

Based on their financial criteria, are Fred and Jan able to qualify for conventional, FHA, or VA financing?

Do the Springs Qualify for a Conventional Loan?

One particular lender offers the Springs a conventional loan that requires at least a 95% LTV, or a maximum loan amount of $171,000 (.95 x 180,000). With a $171,000 loan at 6% interest rate for 30 years, the monthly payment comes to about $1,300 per month with taxes, insurance, and PMI. Will the Springs be able to make this payment?

Most conventional lenders require that the prospective borrower must meet a debt-to-income ratio of 28/36 or 28% of their monthly income for housing expense and 36% of their monthly income for all debts. The maximum monthly payment that the Springs can qualify for is $2,160.

DTI Ratio Calculations
Front Ratio: $6,000 x .28 = $1,680
Back Ratio:  $6,000 x .36 = $2,160

The Springs meet the front-end ratio of 28% as the $1,300 monthly housing payment is well under the $1,680 allowed. For the back end ratio, the $1,300 monthly housing payment plus their total recurring debt of $800 is $2,100. They are under the $2,160 requirement for the back end ratio so they qualify for the conventional loan.

Do the Springs Qualify for an FHA Loan?

The Springs also inquire about getting an FHA loan just in case they do not qualify for conventional financing. FHA lenders also look at the borrower’s debt-to-income ratios to qualify a borrower for a loan. The FHA usually uses a 31% front ratio and a 43% back ratio or a 31/43 ratio. After hearing these qualifying ratios, the Springs decide that they would rather put down only 3.5% or $6,300 to keep more cash in their account.

The FHA lender can offer the Springs the same loan terms as the conventional lender. For a $173,700 loan with a 6% interest for 30 years, the payment amounts to about $1,325 per month including taxes, insurance, and MMI.

DTI Ratio Calculations
Front Ratio: $6,000 x .31 = $1,860
Back Ratio: $6,000 x .43 = $2,580

Once again, the Springs meet the front-end ratio since the $1,325 monthly housing expense is well below $1,860. As for the back-end ratio, their recurring debt plus the loan payment is $2,125 ($1,325 + $800). This means that the Springs can also qualify for an FHA loan with a smaller down payment.

Do the Springs Qualify for a VA Loan?

Since Fred Spring is also a veteran, the couple decide to inquire about a VA loan. A VA lender uses a 41% qualifying ratio and residual income. They use specific charts to determine if a borrower has sufficient residual income to qualify for a loan. The Springs decide to try for a no money down loan to see if they can take advantage of Fred’s veteran status. Below are the calculations for a VA loan with a $180,000 amount and a 6% interest rate for 30 years.

Residual Income

Gross income


  Federal income tax


  State income tax


  Social security


Net take-home pay

$ 4,560

Housing expense and fixed obligations
  Principal & interest


  Property taxes


  Homeowners insurance


  Total PITI


  Maintenance & utilities




  Recurring monthly debts


  Job-related expenses


Total housing and fixed obligations


Residual income


The Springs live in the West. Based on the VA charts provided below, the Springs’ residual income must be $823 or more to qualify for the VA loan. In this case, they are able to qualify for the no money down VA loan.

Table of Residual Incomes by Region

For loan amounts of $80,000 and above
Family Size Northeast Midwest South West
1 $450 $441 $441 $491
2 $755 $738 $738 $823
3 $909 $889 $889 $990
4 $1,025 $1,003 $1,003 $1,117
5 $1,062 $1,039 $1,039 $1,158
Over 5 add $80 for each additional member up to a family of 7.

Qualifying Ratio Calculations

DTI = (housing expense + recurring debt) ÷ gross monthly income
DTI = ($1,280 + $800) ÷ $6,000
DTI = $2,080 ÷ $6,000
DTI = 35%

The Springs’ DTI is 35% so they meet the VA DTI 41% ratio.

The Springs qualify for all three loans—conventional loan with a 5% down payment, FHA loan with 3.5% down payment, and VA loan with zero down.

Underwriting the Property

One of the risk factors associated with approving a real estate loan is the type and value of the property (single-family, condominium, duplex, or rental) used as security for the loan. The property itself is the lender’s primary security for repayment of the loan if the borrower defaults. The secondary security is the promissory note, which is the borrower’s personal promise to pay. The property must be structurally sound and in good repair. The lender’s decision to fund the loan is dependent as much on the value of the property as it is on the borrower’s ability to pay off the loan.

The underwriter wants to make sure that the lender is protected from loss as a result of default and foreclosure by establishing the value of the property to which the loan-to-value ratio is applied. For example, if the lender’s loan-to-value ratio for making the loan is 80%, the loan cannot be more than 80% of the value of the property.

$100,000.00      Value of Property
 X      .80           Loan-to-Value Ratio
$80,000.00       Loan Amount

As far as risk of loss goes, if the property goes into foreclosure the lender can feel reasonably safe if there is a 20% cushion between the loan amount and the value of the property. Lenders do make loans with higher ratios, but these loans inherently involve more risk for the lender. The cost for 80%, 90%, or even 100% loans goes up according to the perceived risk to the lender. Interest rates and points are increased to offset this risk and the buyer is normally required to purchase mortgage insurance on most loans that exceed an 80% LTV.

After reviewing the loan-to-value ratios, loan amount, down payment, income ratios, employment, and credit history in the loan package, the underwriter must determine the adequacy of the security for the loan. Since a real estate loan is secured by the property, the value of the property must be determined to validate the loan-to-value ratio.

Appraising the Property

The value of a property is determined by an appraisal. An appraisal is an unbiased estimate or opinion of the property value on a given date. The purpose of the appraisal is to analyze the current market value of the property and determine if there are any adverse factors that might affect value in the near future. Each property is appraised to determine if it has sufficient fair market value to serve as reasonable security for a loan.

The basic principles of establishing value for property include the interconnected characteristics of the property itself and the real estate market in general. These include physical condition, location, and market conditions. Any deterioration of the physical condition of the property relates to its uses, construction materials, and maintenance. The location of the property can neutralize a number of other faults in the property and is one characteristic of the property that cannot be substituted. Market conditions play a major role in establishing value. The obvious considerations are the current and future market conditions. A soft market indicates a greater supply than demand, whereas a tight market reflects the opposite condition—a greater demand than supply.

Elements That Influence Value

  • Current use of the subject and neighboring properties
  • Type of improvements on the subject property and neighboring properties
  • Whether or not the land size and land-value to total-value ratio are typical for the area
  • Degree, amount, and type of development occurring in the area
  • Pending zoning changes or changes in use of the properties in the area
  • Whether the subject property and neighboring properties are residential and marketable


Appraisal Approaches to Value

The three appraisal approaches used to analyze property value are the sales comparison approach, the cost approach, and the income approach. Each approach analyzes the property from a different perspective.

The sales comparison approach, or market approach, is the one most easily and commonly used by real estate associates. The sales approach depends on recent sales and listings of similar properties in the area that the appraiser evaluates to form an opinion of value. It is best for single-family homes or condominiums and vacant lots because sales information is readily available and easily compared. This approach uses the principle of substitution to compare similar properties.

The cost approach is used to look at the value of the appraised parcel as the combination of two elements. These elements are: (1) the value of the land as if vacant and (2) the cost to rebuild the appraised building as new on the date of valuation, less the accrued depreciation. Appraisers use the cost approach to evaluate construction costs, developer profits, and land costs, and make a downward adjustment for physical depreciation of the subject property.

The income approach is used to estimate the present worth of future benefits from ownership of a property. The value of the property is based on its capacity to continue producing an income. This method is used to estimate the value of income-producing property (rentals), usually in combination with one or both of the other methods. This approach is based mainly on the appraisal principles of comparison, substitution, and anticipation.


Types of Appraisal Reports

The Appraisal Foundation (TAF) requires appraisers to use one of three types of appraisal reports when reporting results. They are the Self-Contained Appraisal Report, the Summary Appraisal Report, and the Restricted Use Appraisal Report. Regardless of the type, each written appraisal report must be prepared according to the Uniform Standards of Professional Appraisal Practice (USPAP). Each report includes the identity of the client and any intended users (by name or type), the intended use of the appraisal, the real estate involved, the real property interest appraised, the purpose of the appraisal, and the dates of the appraisal and the report. Each report also describes the work used to develop the appraisal, including the assumptions and limiting conditions applied, information analyzed, procedures followed, and conclusions supported by appropriate reasoning.

The Self-Contained Report is the most elaborate report and contains the most detailed information. Self-contained means that everything the user of the report needs to fully understand it is contained within the report.

The Summary Report contains less detail than a Self-Contained Report but more than the Restricted-Use Report. It is also the most commonly used type of report. Instead of describing the information in detail, the appraiser summarizes the information. To summarize is to elaborate but not provide every detail required to reach that conclusion.

Information Summarized in a Summary Report

  • Extent of the process of collecting, confirming, and reporting data
  • Information considered
  • Appraisal procedures followed
  • Reasoning that supports the analyses, opinions, and conclusions
  • Appraiser’s opinion of highest and best use of the real estate
  • Any additional information that may be relevant to show compliance with, or clearly identify and explain permitted departures from, the specific guidelines of STANDARD 1 of USPAP

For example, the Uniform Residential Appraisal Report (URAR) is a Summary Report. It contains many fields of information in organized categories and allows for proper summarizing statements and even an addendum to support and clarify concepts when necessary. Most residential appraisals are done on this standardized form and are considered Summary Reports.

Fill out this short form and a mortgage expert will get in touch with you.

  • Section