Manual Underwriting Versus Automated Underwriting System Approval

by Gustan Cho

This Article Is On Manual Underwriting Versus Automated Underwriting System Approval

What is manual underwriting on home mortgages?

All mortgage applications need to go through the automated underwriting system, often referred to as AUS after the loan officer has taken the 1003 loan application, ran a tri-merger credit report, reviewed documents. There are two different types of automated underwriting system. Fannie Mae’s Desktop Underwriter commonly referred to as DU and Freddie Mac’s Loan Prospector also referred to as LP. Fannie Mae’s DU AUS is the more popular AUS used by loan officers. The automated underwriting system is a sophisticated highly technologically advanced computerized system that all loan applications need to go through in order to proceed to the next level. The automated underwriting system can render an automated findings about the borrower’s eligibility in a matter of seconds. To proceed to the next step of the mortgage process, the findings need to render an approve/eligible. An approve/eligible per AUS Findings mean the borrower meets all the minimum agency guidelines. The second findings the AUS can render is a refer/eligible per AUS. A refer/eligible means that the AUS determined the borrower is eligible but cannot determine whether or not the borrower is fully approved. The automated underwriting system refers the file to a human mortgage underwriter for a manual underwrite. The third type of findings from the automated underwriting system is a refer with caution. Refer with caution means the borrower does not qualify for a mortgage. FHA and VA loans are the only two mortgage programs that allow manual underwriting. The main difference between manual underwriting versus automated underwriting system  is caps on debt to income ratios. Everything else is pretty much the same. Mortgage underwriters have a lot of underwriter discretion on manual underwrites. Compensating factors are important on borrowers with higher debt to income ratio on manual underwriting.

How Does The Automated Underwriting System Work In The Mortgage Process

With an approve/eligible per AUS, loan officers who work at mortgage companies with no lender overlays can issue a pre-approval letter. Loan officers who work at mortgage companies need to make sure borrowers meet their lender overlays after the AUS approval. Loan officers who work at mortgage companies with lender overlays need to go through a second tier of the pre-underwriting process and check if the borrower will meet their company’s lender overlays. For example, if a borrower with a 580 FICO got an approve/eligible per AUS on an FHA loan with a 580 FICO but the mortgage company has overlays on credit scores of 620, the borrower will not qualify at that particular lender. Lender overlays are higher lending requirements above and beyond the minimum agency guidelines of FHA, VA, USDA, Fannie Mae, Freddie Mac. Most lenders will have lender overlays. Lenders can impose lender overlays on just about anything and everything. The good news is Capital Lending Network, Inc. has no lender overlays on government and conventional loans. We just go off the AUS findings. We have zero lender overlays. An approve/eligible means the borrowers will close the loan if they meet all the conditions listed on the AUS approval.

Automated Underwriting System Approved Borrower Downgraded To Manual Underwrite

There are cases where automated underwriting system approved borrowers get downgraded to a manual underwrite by the lender. What is the reason for getting the file downgraded to manual underwrite?  That is up to the lender. It does not need to be downgraded but the lender may feel the file is just too risky for an automated underwriting system approved underwrite. If the borrower does not feel comfortable with the manual downgrade, they can transfer the file to another lender that will not downgrade the file. Normally smaller mortgage bankers who do not want to take a lot of risk often manually downgrade AUS approved borrowers. Mortgage underwriters will carefully review a loan applicant’s loan application, credit report, and mortgage documents. The underwriter will go over the borrower’s overall credit/income profile and the reasoning for the manual underwrite. The mortgage processor will have all the documents ready and labeled for the mortgage underwriter to review the file with ease which includes detailed letter of explanations.

Preparing The File For Mortgage Underwriting

Mortgage underwriters will not look at files that has documents that are not legible, missing pages, not properly labeled, or that is not clear. If a file is confusing and not clear to the mortgage underwriter, it will get kicked back and/or placed in suspense. An experience mortgage processor will not submit a file to the underwriter unless the file is complete and easy for the mortgage underwriter to review and render a decision.

The following documents will be carefully reviewed and analyzed by the mortgage underwriter during a manual underwrite:

  • Summary report for the mortgage underwriter about the borrower
  • 60 days of bank statements and/or other asset information
  • Two years income tax returns, W2s, 1099, P and L, retirement accounts(if being used for qualified asset verification) and/or other income documents that are applicable
  • Full complete bankruptcy documents, foreclosure/deed in lieu of foreclosure/short-sale documents if applicable
  • Completed mortgage loan application, credit report, AUS Findings Report
  • Verification of employment
  • Verification of rent
  • Letter of explanation for recent credit inquires and the outcome of the inquiries
  • Letters of explanation for derogatory credit tradelines, outstanding collections/charged-off accounts, prior bankruptcy and/or a housing event
  • List of compensating factors and supporting documents

The mortgage processor should have a file neatly organized, labeled, and complete for a mortgage underwriter.

Cases When The Borrowers Need Manual Underwriting

There are instances where a file needs to be manually underwritten. The only FHA and VA loans allow for manual underwriting.

Here are cases where borrowers need manual underwriting:

  • Borrowers with no credit scores and no credit tradelines need to be manually underwritten
  • Borrowers with no credit scores and no traditional credit tradelines can use nontraditional credit 
  • Nontraditional credit are creditors that do not report on credit bureaus such as utilities, cell phone carriers, education, insurance payments, and other creditors
  • Borrowers in Chapter 13 Bankruptcy repayment plan can qualify for an FHA and VA loans during the repayment plan 
  • Borrowers need to be in Chapter 13 Bankruptcy repayment plan for at least 12 months to be eligible for an FHA and/or VA loan 
  • Chapter 13 Bankruptcy does not need to be discharged to qualify for FHA and/or VA loans during Chapter 13 repayment plan
  • Bankruptcy trustee approval required
  • All FHA and/or VA loans during Chapter 13 Bankruptcy repayment needs to be manual underwriting
  • Manual underwriting guidelines apply
  • There is no waiting period requirements after Chapter 13 Bankruptcy discharged date on FHA and VA loans
  • Any Chapter 13 Bankruptcy discharge not seasoned for at least 24 months needs to be manually underwritten
  • Borrowers with outstanding credit disputes who cannot get rid of the disputes can be manually underwritten

There are instances where lenders will just downgrade an approve/eligible per AUS file to a manual underwrite. This is up to the lender and is often done due to lender overlays. The individual lender may feel the automated approved borrower is just too risky for them and the only way they will proceed is through manual underwriting. For example, borrowers with automated underwriting system approvals with larger collections/charged-off accounts, late payments after bankruptcy/foreclosure, high debt to income ratios, or those with other layered risk factors under the eyes of the lender may be downgraded to a manual underwrite. Again, a downgrade from a AUS approved findings can be downgraded to manual underwriting depending on the lender.

Manual Underwriting Guidelines On Debt To Income Ratio

Mortgage underwriters has a lot of underwriter discretion when it comes to debt to income ratio on manual underwriting. Here is the general recommended debt to income ratio guidelines on FHA and VA loans on manual underwrites:

  • 31% front end and 43% back end debt to income ratio for borrowers with no compensating factors
  • 37% front end and 47% back end debt to income ratio for borrowers with one compensating factor
  • 40% front end and 50% back end debt to incomer ratio for borrowers with two compensating factors

Borrowers with higher than the above debt to income ratios can exceed those caps if the mortgage underwriter uses her discretion due to borrowers having strong compensating factors.

Importance Of Compensating Factors On Manual Underwriting

Importance of compensating factors on borrowers with higher debt to income ratio on FHA and VA loans. Debt to income caps on manual underwriting depends on the number of compensating factors borrowers have. Compensating factors are positive factors borrowers have that reduce the layered risks of lenders.

Here are compensating factors mortgage underwriters take into consideration:

  • Low payment shock of 5% or less
  • Part-time and/or other income not used as qualified income but the borrower has a history of making such income for a period of at least 12 months
  • Borrowers who have a history of saving money over the course of the past few years
  • All manual underwrites require one month of reserves
  • Having three or more months of reserves is considered a strong compensating factor
  • Larger down payment means the borrower has skin in the game and is less risk for the lender if the borrower defaults forecloses
  • The borrower has a non-borrowing spouse with full time income

Mortgage underwriters have a lot of power and discretion on manual underwriting. Mortgage underwriters can exceed the 40% front end and 50% back end debt to income ratio caps on manual underwriting if the underwriter sees multiple compensating factors. Again, mortgage underwriters have a lot of underwriter discretion on manual underwriting borrowers. Each manual underwriting borrower is underwritten on a case by case scenario basis.

7 comments

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7 comments

Gustan Cho NMLS 873293 November 28, 2020 - 7:51 pm

You need to enter into a written payment agreement with the state of Pennsylvania and the IRS

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Melissa Reddeck November 28, 2020 - 8:04 pm

I’m looking to see if I can qualify for a VA home loan in Ohio.

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Gustan Cho November 28, 2020 - 8:07 pm

I’m considering getting my individual and my broker license to go into business for my self my home state of PA. I was wondering if you knew anything about the PA process. I owe the state about 850 and the federal government about 3500, and my mortgage is in the Covid forbearance program. Otherwise I have a 640 credit and nothing derogatory. Do you think I’ll have any problems?

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Melissa Walker November 28, 2020 - 8:08 pm

I’m considering getting my individual and my broker license to go into business for my self my home state of PA. I was wondering if you knew anything about the PA process. I owe the state about 850 and the federal government about 3500, and my mortgage is in the Covid forbearance program. Otherwise I have a 640 credit and nothing derogatory. Do you think I’ll have any problems?

Reply
Bonnie Miller November 29, 2020 - 9:14 pm

Hello – we live in NYS but I found your site while googling information. I’m not sure if you can help me since we are in different states. We had a deed in lieu it will be 4 years ago in January. We would like to apply for a mortgage in January. We are interested in using the Fannie Mae 97 Conventional Loan program because we are looking for a lower down payment option. Do you know if we can apply for that program after a DIL? Do you know if we have to have a higher down payment due to the DIL? Thank you very much for your assistance. Take care

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Mark and Susie S. December 2, 2020 - 12:11 am

Want to thank Alex Carlucci of Gustan Cho Associates for helping me and my family become a homeowner. We closed on our home two weeks ago after going through many lenders who told us we did not qualify for a mortgage during Chapter 13 Bankruptcy repayment period. We finally did it. Alex Carlucci and the team and staff at Gustan Cho Associates are miracle workers and Angels sent by God in helping my family become homeowners. We love our home and never in my lifetime could I have imagined that my wife and I could have ever own such a beautiful home. Amazing people at Gustan Cho Associates.

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Linda Simpson McCarthy December 25, 2020 - 8:48 pm

A great article was written by Gustan Cho on how Compensating Factor comes into play on manual underwriting borrowers who have a higher debt to income. I just wanted to thank Alex Carlucci of Gustan Cho Associates for posting informative videos about mortgages. I am a licensed loan officer in Las Vegas Nevada and want to thank Gustan Cho Associates and Capital Lending Network, Inc. for being my mentor in the mortgage business and helping me become a top producer. The blogs published on Gustan Cho Associates and Capital Lending Network, Inc. are hands down priceless. Keep up the great work Gustan Cho Associates and Capital Lending Network, Inc.

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