Underwriting is the process lenders use to determine if you can be approved for the home loan you’ve requested. When it comes to how underwriting is done, you have two different options:
- Automated Underwriting
- Manual Underwriting
If you’ve had past credit issues you may need to consider using manual underwriting in order to give yourself the best chance of getting approved. Not all lenders offer manual underwriting so if you’ve been denied by a lender, you should check with a lender who does offer manual underwriting.
What Is Manual Underwriting?
Manual underwriting is the process in which an underwriting reviews your file, looks at all your documentation, and determines whether or not you can be approved for a home loan. The manual underwriting process is more rigorous and you will be required to provide more documents than with automated approval.
The underwriter is going to look at factors such as:
- Credit Score
- Employment History
- Credit History
- Cash Reserves
- Debt-to-Income Ratio
- Rent Payment History
The underwriter is likely to ask you to explain things about your financial past in a letter of explanation. You’ll need to be detailed in your explanation of what happened, why it happened, and how you’ve fixed it moving forward.
Since manual underwriting is left up to the underwriter’s discretion you should expect the process to be more invasive into your personal details. While this can be frustrating for some, if you stick with the process you can usually get the house you want.
When Is Manual Underwriting for a Mortgage Required?
When you apply for a mortgage your lender is going to run your application through an Automated Underwriting System. There are three major AUS in the mortgage industry:
- Desktop Originator
- Loan Prospector
- Guaranteed Underwriting System
Each one of these systems has different algorithms and criteria that borrowers need to meet in order to be approved.
There are three potential findings or results:
- Approve/Eligible
- Refer/Eligible
- Refer with Caution
Manual underwriting is going to be required if you receive a Refer/Eligible result. Refer with caution will not qualify for a manual underwrite because the overall quality of the application is too low to be approved.
Manual Downgrades
There are also cases where you may receive an automated approval but due to factors on your loan, the lender will require your loan to be automatically downgraded to a manual underwrite.
Manual Downgrade Cases:
- Chapter 13 Bankruptcy still in Repayment
- Bankruptcy that’s not seasoned for 24 months
- Disputed collection accounts over $1000
- No credit score
Your Loan Officer Matters
Who you work with matters regardless of automated or manual underwriting, but it’s critical in a manual underwritten loan. The last thing you want to do is work with someone new who has never done a manual loan before.
A good loan officer knows how to improve the quality of your application, especially if you get a refer with caution. They can look at factors such as debt-to-income ratio, cash reserves, and other factors to try and help your loan get approval.
Working with a mortgage broker can also make a difference because they have access to multiple lenders. If you work with your local bank or credit union, you’ll probably be denied if you need a manual underwrite.
Mortgage brokers have dozens of lenders they work with and many of them offer manual underwriting with no overlays.
Manual Underwriting vs. Automated Underwriting
With automated underwriting the lender is going to receive an automated approval in minutes, and as long as you can prove the information on your loan application your loan will be approved. An underwriter will still review your application and documents, but the process overall is much simpler.
What Are Compensating Factors?
Compensating factors are additional positive items on your mortgage loan application. When you have one or more compensating factors the underwriter will look at your loan application more favorably, and you may be able to get approved for more than you otherwise could
Compensating Factors Include:
- Reserves
- Low payment shock– your mortgage payment is around the same as your rent
- Additional income the underwriter couldn’t use
- Limited Debt
- Good employment history with the same employer
Compensating factors are going to be required when you need to increase your purchase price because your debt-to-income ratio is above the basic requirements.
What Are Mortgage Reserves?
A mortgage reserve is equal to one month of your total mortgage payment and must be money left over after you’ve paid your closing costs and down payment. Mortgage reserves are required on any manually underwritten loan. Reserves must be your money, you cannot use gift funds or funds from anyone else.
You can use your retirement accounts or investment accounts for reserves as well, but only about 70% of your vested balance.
You can still get gift funds to cover your down payment and you can use gift funds or seller-paid credits for your closing costs. If you are tight on funds you’ll want to make sure to negotiate for these when you make an offer on the home.
What is Rent Verification?
Rent verification is the process when your lender verifies that you’ve been making your monthly rent payments on time. In order to be approved for a manually underwritten loan, you have to prove that you are not paying your rent late.
Lenders will typically use a form that they will send to your landlord and the landlord will complete it and sent it back to them. If you are renting from an individual you’ll also be required to provide a canceled check or 12 months of bank statements in order to prove your rent payments.
If you make cash payments, there will not be a way to prove your rent payments unless you are renting from a larger organization and can get away with a simple VOR (Verification of Rent)
FHA Manual Underwriting Guidelines
FHA is one of the most common manually underwritten loans in the United States. Since FHA has flexible credit requirements, it’s a great program for credit-challenged borrowers.
FHA has a few different requirements in order to be approved.
- Credit Score of 500 or Higher
- Debt to Income Ratio Under 43%
- One Month Reserves
- One Year Rent Verification
With 1-2 compensating factors you may be able to increase your debt to income ratio to 50%
VA Manual Underwriting Guidelines
The VA loan is perfect for active duty and veteran homebuyers who want a great loan without a down payment requirement.
VA Loans require:
- Credit Score of 500 or Higher
- 43% DTI Ratio
- One Year Rent Verification
If you exceed 43% DTI you’ll need to:
- Meet residual income requirements
- Have at least 1 compensating factor
- Have at least 2 months reserves
USDA Manual Underwriting Guidelines
Many people believe that you need to have at least a 640 credit score in order to qualify for a USDA Rural Development Loan. However, that’s only for automated approval. USDA doesn’t have a minimum credit score requirement, but most lenders require at least a 580.
USDA requires:
- Credit Score of 580 or higher
- 29%/41% Max Debt-to-Income Ratio
- 3 Months of Reserves
- 12 months of rent verification
So even with less than perfect credit you have the ability to get a home loan without a down payment. USDA is fairly flexible with its requirements.
How Long Does Manual Underwriting Take?
The process for manual underwriting doesn’t take much longer than loans that have automated approval. You may have to wait a few extra days but overall it’s still possible to close your loan on time.
The primary factor in speed is how quickly you can get the documents to your lender. Since there will be more documents you need to provide, speed is the key.
Documents you should be prepared to have include:
- Last two years W2’s
- Last 30 Days of Paystubs
- Most Recent 60 Days Bank Statements
- Driver’s License
- Last Two Years Tax Returns
- An explanation for late payments, collections, and other negative credit items
- Last 12 months of canceled rent checks
Read: What Documents Are Needed To Buy a Home?
Overall, being flexible and understanding during this process will ensure you have success. If you’ve had past credit issues many lenders may tell you no. Finding the right lender and trusting them to get the job done can get you in the home you dream of.
