The 3 Cs of Loan Underwriting Approval

(Jeff Sorg, OnlineEd) – When making a residential real estate loan application, qualifying ratios are only the beginning of the approval process. The “Three Cs” of loan underwriting approval are:

  1. Credit – the credit history of the applicant;
  2. Capacity – the income and ability to service the desired loan debt; and
  3. Collateral – the value of the property being purchased and pledged as collateral in the event of default.




Credit refers to the credit worthiness of the borrower. Lenders start with a combined credit report from the three standard national credit reporting agencies – Equifax, Experian, and Trans-Union. The information and credit scores contained in the report provides the foundation for approval, which type of loan will be best for the borrower, the interest rate to be charged, or grounds for denial. The credit history of the borrower is the most important consideration in granting a mortgage.

The Fair Credit Reporting Act requires credit reporting agencies to furnish a borrower a copy of their credit report, at no charge, if a borrower is denied credit.

Credit scoring considers a variety of components. While the element of how much one owes, along with payment history is objective,  several subjective elements are considered to determine the credit score of a loan applicant. For example, if credit account balances are 75% or more of the credit limit, this signals a high financial leverage and a higher risk for the lender. Keeping a large amount of open accounts with zero balances can also lower the credit score, since it increases the potential for more debt after the loan is given.

The Fair Credit Reporting Act requires credit reporting agencies to furnish a borrower a copy of their credit report, at no charge, if a borrower is denied credit. When a borrower notifies credit reporting agencies of an error in a credit report, the credit reporting agencies are required to verify and correct the error. Borrowers also have a right to include a statement of explanation for derogatory information released in their credit report.

Real estate licensees should always include a frank discussion about derogatory credit information and emphasize the value of working with the mortgage broker for appropriate credit report repair action before making a loan application.


Capacity refers to the borrower’s ability to repay or service the loan, with emphasis is placed on two ratios. The first is the borrowers monthly proposed housing costs, including PITI (plus homeowners association dues, if any) to total gross income. Most lenders look for a ratio that does not exceed 28%. FHA allows up to 29%. The second ratio is the borrower’s total debt payments (inclusive of the proposed loan) to the borrower’s gross monthly income. Most lenders do not allow this to exceed about 36%. FHA and VA allow up to 41%. If a borrower qualifies comfortably on one of the ratios, a lender may allow a little leeway on the other.

Additionally, the employment history of the borrower is taken into consideration. The employment history evaluates such factors as the reliability and stability of the borrower’s income, length of time on the job, type of occupation, overtime pay and bonuses, as well as probability of continued employment.

Another factor is the net worth of the borrower. Net worth is determined by subtracting total liabilities from total assets. Fannie Mae regards “an accumulation of net worth as a strong indication of credit worthiness.” Additionally, the underwriter, by establishing net worth, is evaluating the ability of the borrower to cover the down payment and any additional costs and expenses relating to the purchase, as well as verifying adequate cash reserves (if a required condition of the loan approval).


Collateral refers to the value of the property being purchased, which is being pledged as collateral for the loan. Collateral is a critical element, as it is here that the lender looks to hedge its loss in the event of borrower default. The loan to value ratio is applied to the lesser of the sales price or appraised value. Accordingly, the appraised market value either supports or questions the element of collateral.

Once the collateral and the borrower have been evaluated by the underwriter, a summary is submitted to a loan committee, which makes the final decision on whether to approve the loan. If the committee approves the loan, a loan commitment letter is issued to the borrower. The commitment letter is a written agreement by the lender to make the loan, subject to any specific terms and conditions listed therein.


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