You Through the Underwriter’s Eyes — Capacity

What is an underwriter? This is the person who will review your file to make sure you meet the guidelines set forth by the program you’re doing.  Underwriters determine if you are a good credit risk for the bank or lender, so they look at four different aspects of your situation.  We call these the four C’s to underwriting – capacity, credit, cash and collateral.  This blog focuses on your income and employment, which fall under capacity.

Employment is NOT necessary to get financing, but what is necessary is income to determine you have the ability to repay your new loan plus any other debts you have. Non-employment income can come from social security, disability, pension, alimony, child support or even interest you’ve earned via investments.  Depending on the loan program you’re doing, we need to verify a history of receipt and determine that it will continue for at least three years.  Depending on the income type, the methods we use to verify the income will vary.

With employment, the underwriter is looking at past history and the likelihood of job continuation. We realize that no one knows when a job may end, but past history and a current verification from your employer will help us answer that question.  Sometimes an employer will write “no” in the box labeled “probability of continued employment.”  If that happens, we may have a difficult time justifying the employment, thus income, we are using for your qualifications.

The underwriter is also looking for a two-year work history if we are using employment income for qualifying. You don’t need the same job for the last two years, though that’s certainly preferable.  If you had been out of work for an extended period of time, say three – six months, you may have to be on your new job for a certain timeframe to use the income for qualifying.  That timeframe will vary on programs.  We still would need to verify a two-year work history prior to the time off.  If you were a student in the last two years, for instance, we can use this as part of your “job” history and would obtain unofficial transcripts from you to prove this.

If you have a history, especially in the last 12 months, of changing jobs frequently (more than two – three times), this may make it tougher to use the income as well since it’s hard to predict, based on history, that the current job we’re using for income will be stable. Certainly, people change jobs to get better pay, hours or even benefits.  We aren’t faulting you for bettering your situation and applaud that, but frequency of those changes could be harmful.

What about changing jobs in the process? It is certainly acceptable to do so, but you should always check with your loan officer first.  Remember, underwriters are using your current income pay structure to determine your qualifications.  Let’s say you are a salaried employee now and have the option to go to a base (less per year) plus commission.  My guess is you may take this option since you may have a higher earning potential.  The problem is that lenders can only use the commission income for qualifying if you have a two-year history of receiving this type of income.  If you don’t, then the numbers the lender has given you would be inaccurate since they were based on the higher salary, not the lower new base pay.

And yes, we really like things in two’s! For instance, when it comes to income, or your capacity, we look at types of income differently.  If you are salaried, we can use that as your income and like any proof, we will confirm this with recent paystubs, W2s and possibly tax returns.  If you are hourly, and you work the same hours per week, we can use that easily enough.

If you work variable hours, then we may need to average your income over the last two years and current year to determine what your monthly income works out to be. Commission, overtime, bonus, tips and self-employment all need to have a two-year history to use it for qualifying.  Sometimes, a lesser time frame is allowed, but that is dependent on the type of income and loan program you’re doing, as well as your specific situation.  This income, since variable, will be averaged over 24 months and if it’s declining, we may have to use the lower income or could not use it.

Interestingly, lenders will use your GROSS income to determine qualifications (unless you’re self-employed, then net is used). Seems a little odd to do this since you don’t get that much in your paycheck, do you?  But, we have to put all people on the same playing field.  If two people had the same salary, but one opted to put max into their 401K and the other had health insurance costs, their net income would be vastly different, possibly giving one person more qualifying ability over the other.  So, we use gross income and we use something called ratios to determine your qualifications.  This just means, based on the program you’re doing, we take a percentage of your gross income and subtract your monthly obligations to determine a maximum payment you can afford – but that’s another blog!

In the lending puzzle, capacity – income and employment, is just one piece of how you are looked at from the underwriter.  Next up will be credit and really, for some, that is the cornerstone of starting your financing process.