Conventional Mortgages

The different types of mortgages all have different rules the lenders must use when making a loan.  The three basic types are grouped under the general headings of Conventional, Government and Portfolio loans.  The names imply where the money actually comes from.  The lines have gotten somewhat blurry in recent years as the federal government has taken on a larger role in the mortgage industry.

This section is devoted to Conventional loans and the underwriting guidelines that must be followed.   Conforming Conventional Mortgages are usually funded with money from either Fannie Mae or Freddie Mac.  Those two companies fund the majority of conventional mortgages in the US.  They sell bonds backed by mortgages and anyone can purchase one of their bonds.

The bonds are sold by stockbrokers to investors that range from the largest of pension funds to your grandmother.  When the stockbroker sells your grandmother a bond she grills him about the safety of the security she is buying.  Granny wants to be sure she gets her money back.  So the broker shows granny the prospectus that outlines the transaction and granny receives all kinds of promises from the contract.  In that document she is promised that the money will only be lent to credit worthy home buyers. 

Granny wants to know how creditworthy the borrowers are going to be so the broker says no one with a credit score below 640 will get a loan using her money.  

She asks how he knows they will be able to pay it back, only borrowers with income to debt ratios below a certain level will be approved for a loan, etc., etc., etc. 

When granny is finished asking her million questions the answers are all right there in black and white and poof, we have underwriting guidelines.  Now you know who is to blame for making it so hard to get a loan, that old loan shark granny!    

A fundamental difference between a conventional loan and a government loan type is how the investor that buys the bond is protected.  The size of down payment is larger for a conventional loan, 20% of the purchase price unless the borrower purchases mortgage insurance.  You have probably heard this referred to as PMI which is short for Private Mortgage Insurance.   

PMI insures the mortgage against default by the borrower.  If the borrower stops making payments the insurance company must pay off the mortgage.  Granny gets her money back.

The best way to understand what underwriting guidelines are is to visualize a massive rule book divide into several sections.  Every section defines all of the boundaries for every aspect of the decision making process.  For example, the section on Income would define all of the types of income a borrower may have from which the mortgage payments can be made.  Some types of income are not acceptable; the guidelines clarify what is and what is not.  

For example, a few years back I had an applicant ask me to count money he had stolen from his employer.  I bet you think that is not allowed, not true.  There is nothing in the guidelines that says theft is not an acceptable form of income, but verifying his receipt of the money was a problem.  He would need to prove he had been receiving it for at least two years and that it was likely to continue for another 3 years.  We needed copies of his tax returns showing he paid taxes on it last year and the year before and something from his employer saying it was likely to continue for the next three years.  His criminal activity did not meet the necessary guidelines for counting his income.

There are four areas that must be considered for all mortgage loans, regardless of the type of application.  

Credit

Capacity

Collateral

Cash

Credit Standards for a Conventional Mortgage

A mortgage credit report is a very detailed document containing almost every bit of information about the financial transactions of an individual.  Many creditors supply transactional data to one of the three credit repositories, Equifax, Transunion or Experian.  A data company retrieves and assembles the information and provides the lender with a credit report.  There …

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