Mortgage Underwriting Principles Questions and Answers — Questions and Answers
Question 1: An underwriter is analyzing a loan application where the borrower's debt-to-income (DTI) ratio is slightly above the standard guidelines for a conventional loan. However, the borrower has a high credit score, significant cash reserves, and is making a large down payment. These positive factors are known in underwriting as:
- Conditional approvals
- Layered risks
- Compensating factors (Correct answer)
- Loan stipulations
Correct answer: Compensating factors
Compensating factors are positive elements of a loan file that can offset negative aspects, such as a high DTI ratio. Strong credit, significant reserves, and a large down payment are all common examples of compensating factors that an underwriter can use to justify approving a loan that might otherwise be denied.
Question 2: A loan officer submits an application to an Automated Underwriting System (AUS), and the finding is 'Refer/Eligible.' What is the most accurate interpretation of this result?
- The loan is automatically approved, pending verification of documents.
- The loan is denied and cannot be approved by the lender.
- The AUS cannot issue a decision, and the loan must be reviewed by a human underwriter. (Correct answer)
- The loan meets the criteria for the program but is considered high risk.
Correct answer: The AUS cannot issue a decision, and the loan must be reviewed by a human underwriter.
A 'Refer/Eligible' finding from an AUS, like Fannie Mae's DU or Freddie Mac's LP, means the system cannot issue an automated approval based on the data submitted. The 'Refer' indicates that the loan requires manual underwriting by a human underwriter to make a final decision, while 'Eligible' signifies that the loan appears to meet the basic eligibility requirements of the loan program.
Question 3: When underwriting a loan for a self-employed borrower who is a sole proprietor, which IRS form is most critical for verifying their business income and expenses?
- Form 1120S (U.S. Income Tax Return for an S Corporation)
- Form 1065 (U.S. Return of Partnership Income)
- Form W-2 (Wage and Tax Statement)
- Schedule C (Profit or Loss from Business) (Correct answer)
Correct answer: Schedule C (Profit or Loss from Business)
Schedule C, which is filed with the personal Form 1040, is used to report income or loss from a business operated as a sole proprietorship. Underwriters use this form to analyze the business's revenue, expenses, and ultimately the net profit that can be considered for qualifying income.
Question 4: Which of the following would an underwriter consider the riskiest loan scenario, likely requiring a higher down payment and stricter qualifying criteria?
- A rate-and-term refinance on a primary residence.
- A purchase loan for a second home located 100 miles from the borrower's primary residence.
- A cash-out refinance on a primary residence.
- A purchase loan for a single-family investment property. (Correct answer)
Correct answer: A purchase loan for a single-family investment property.
Lenders view investment properties as the highest risk because borrowers are more likely to default on a rental property than their own home during financial hardship. Consequently, underwriting guidelines for investment properties are the strictest, typically requiring larger down payments (often 15-25%), higher credit scores, and more cash reserves compared to primary residences or second homes.
Question 5: Fannie Mae's Collateral Underwriter (CU) is a tool used in the underwriting process primarily to:
- Verify the borrower's income and employment stability.
- Assess the risk associated with the property appraisal. (Correct answer)
- Determine the borrower's final debt-to-income ratio.
- Check for undisclosed liabilities on the borrower's credit report.
Correct answer: Assess the risk associated with the property appraisal.
Collateral Underwriter (CU) is an automated risk assessment tool from Fannie Mae that specifically analyzes appraisal reports. It uses a large database to evaluate the appraisal for potential over or undervaluation, quality issues, and compliance with eligibility policies, assigning a risk score to help lenders manage collateral risk.
Question 6: During a final review of a loan file just before closing, an underwriter notices a recent, large, and undocumented deposit in the borrower's bank account. This discovery is considered a significant underwriting 'red flag' primarily because it could indicate:
- The borrower received a legitimate gift from a relative.
- The funds are from an undisclosed and unacceptable loan.
- The borrower recently sold personal assets to raise cash. (Correct answer)
- The borrower received an annual bonus from their employer.
Correct answer: The borrower recently sold personal assets to raise cash.
A large, undocumented deposit is a major red flag because it raises questions about the source of the funds. Underwriters must verify that the borrower's funds for closing are from acceptable sources. An unverified deposit could represent an undisclosed loan that must be included in the DTI ratio, or it could be from other unacceptable sources that would render the borrower ineligible.
Mortgage Underwriting Principles Questions and Answers
An underwriter is analyzing a loan application where the borrower's debt-to-income (DTI) ratio is slightly above the standard guidelines for a conventional loan.
However, the borrower has a high credit score, significant cash reserves, and is making a large down payment.
These positive factors are known in underwriting as: