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MLO Training: e-Learning: How To Qualify and Pre-Approve a Borrower
In this thread of MLO Training e-Learning we will dive deeply into How to Qualify and Pre-Approve a Borrower and when to issue a pre-approval letter. One of the most common reasons for stress during the mortgage process and a last minute mortgage loan denial is because the MLO issued a pre-approval letter to a homebuyer without properly qualifying the borrower. We will cover the initial interview with the mortgage loan applicant, questions to ask applicants, important questions about their current job, years of employment, type of employment, type of earnings (hourly, salary, income, full or part-time, irregular income, bonus income, social security income, pension income, alimony and/or child-support, royalty income, W2 wage earner or 1099 wage earner, self-employment if applicable, co-borrower(s), non-occupant co-borrowers if applicable, and most importantly, How Much House Can I Afford vs How Much House Can I Qualify. We will dive deep into the applicant’s current credit scores, credit payment history, current liabilities, derogatory credit tradelines, such as outstanding collections, charge-off accounts, judgments, tax lien, bankruptcy, or housing event. We will also cover credit disputes, credit tradelines that is not reporting on credit reports that will get discovered via when a lender does a third-party national public records search such as delinquent federal student loans and other public records. We will cover the documents MLOs will request borrowers, the APPLY NOW link and how it works, and the Credit Report Link and how that works.
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The content below centers new MLOs on best practices and informs them about common underwriting mistakes.
Common mistakes made by new mortgage loan originators include issuing a pre-approval letter prematurely. An actual pre-approval is not a guess or based on a hunch. An actual pre-approval requires the originator to verify the data and documentation and to complete a thorough analysis of the borrower’s credit, income, assets, and liabilities. This is one of the most common reasons a loan is denied at the last minute.
Initial Borrower Interview
A detailed borrower interview is the first step in a pre-approval process and must be conducted to answer the most important questions required to build the loan file.
During the interview, you will need to obtain the borrowers:
- name, Social Security number, and residency status
- current housing situation
- potential purchase price and down payment
- type of housing (primary, secondary, investment)
- co-borrowers and non-occupying co-borrowers
The interview is also the most appropriate time to explain what pre-approval is and what it is not.
Employment and Income Analysis
Of all the borrower qualifying factors, income is one of the most important. A completely different approach is required, rather than simply asking, “what do you make?” to determine income.
Ask and confirm:
- Length of employment (two-year history standard)
- Employment type (W2, 1099, self-employed)
- Payroll structure (salary, hourly, commission, bonus, overtime)
- Consistency of income (at least two-year history)
- Other income, such as:
- Social Security benefits
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- Pension
- Alimony or child support (must be continuance tested)
- Rental income
- Royalty income
When reviewing self-employed applicants, assess business stability, income trends (declining or increasing), and the tax return.
Credit Evaluation and Debt Assessment
A credit report includes more than a score.
Review:
- Credit scores (qualifying middle)
- History of payments with recent late payments
- Revolving v. installment debt
- Debt-to-income (DTI)
- Negative credit events:
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- Collections and charge-offs
- Judgments or liens
- Tax liens
- Bankruptcy and foreclosure
Be careful of disputed tradelines. Some loan programs will not allow a closing with disputed tradelines.
Be aware of liabilities that are not reported on a credit report, such as:
- Federal delinquent student loans
- Federal IRS payment plans
- Undisclosed debts that are discovered through public record searches
Assets and Documentation
Do not issue a firm pre-approval without reviewing the documentation that supports the request.
The following is a frequently required list of documentation:
- The last thirty (30) days of paystubs.
- The last two (2) years of W-2’s or 1099s.
- The last two (2) months of bank statements.
- Government-issued photo identification (ID) and social security (SS) verification.
For the self-employed
- Two (2) years of personal and business tax returns.
- Year-to-date (YTD) profit and loss (P&L) statement.
How Much House Can They Afford vs. How Much House Can They Qualify For
MLOs must make this distinction clear to applicants.
- Qualify: Based on the lender’s policies, income, credit, and debt-to-income (DTI) ratios.
- Afford: Based on the borrower’s comfort level, lifestyle, and financial goals.
There are maximum loan amounts that an applicant can qualify for, but a loan of that amount is often not in the applicant’s best financial interest. MLOs must help applicants understand what the monthly payments (P+I+T+I+HOA) would be, including their other financial obligations.
When you should be issuing a pre-approval letter:
A pre-approval letter should be issued only:
- When credit has been pulled and reviewed
- When income has been calculated and documented
- When assets have been confirmed
- When DTI has been run through the automated underwriting system (AUS)
- When no other major issues have been identified and resolved
If any of these steps are omitted, you are issuing a weak pre-approval, which is a huge disservice to your applicant and may lead to denial.
APPLY NOW and Credit Report Link
To help you stay process compliant:
- APPLY NOW link: Let’s applicants securely submit a full loan application online.
- Credit Report Link: Lets the loan officer pull credit and review liabilities.
MLOs must especially encourage applicants to do both early in the process to prevent surprises.
Final Thought
There are many benefits to receiving a strong pre-approval for everyone involved in the buying and selling process. When MLOs take the time to pre-qualify buyers, the process is less stressful and more efficient. MLOs have a greater responsibility to homebuyers than simply loan approval. They must ensure buyers are ready for the process.
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Understanding AUS Findings: Approve/Eligible vs. Refer/Eligible and What It Means for MLOs
For a complete borrower qualification, you must also evaluate AUS (Automated Underwriting System) findings after submitting the file through AUS (e.g., DU, LP). AUS findings will indicate whether the file is pre-approvable or requires additional steps to support processing.
New MLOs often issue a pre-approval letter without reviewing the AUS findings. This step is crucial, and failing to complete it typically results in the loan being denied at a later stage.
Approve/Eligible Findings
An Approve/Eligible finding states that a loan is compliant with automated underwriting by the input of AU findings.
Here is what it states:
- The borrower satisfies the credit and AUS requirements of income and assets.
- The loan’s risk has been accepted by the system.
- The file is eligible for purchase by Fannie/Freddie (DU/LP, respectively)
Even so, the loan is not fully approved.
You still must:
- Validate AUS findings and all income and employment.
- Confirm and clear any conditions in the AUS findings.
- Validate assets and the source of the funds.
- Review credit for any undisclosed or inaccurate debts.
A common phrase in the industry is, “Garbage in, garbage out.” Should any erroneous data be entered into AUS, an approval is of no value.
Refer/Eligible Findings
A Refer/Eligible finding indicates that although the loan cannot be accepted due to an automated underwriting decision, it may still be accepted via manual underwriting.
This means that:
- The system cannot automatically determine the borrower’s risk profile.
- The final decision will be made by a human underwriter.
- More conservative guidelines will be implemented.
The most common reasons for Refer/Eligible findings include:
- Low credit scores
- High debt-to-income ratios
- Thin credit profiles
- Recent negative credit events
- Inconsistent income
Given the findings for these files, you must be especially cautious when considering any form of pre-approval.
In general, you should only consider issuing a conditional pre- approval or pre- qualification when:
- Documentation is reviewed in full of strong compensating factors. (Reserves, low DTI, and employment with manual underwrite)
When NOT to Issue a Pre-Approval
Do NOT issue a pre-approval if:
- AUS findings have NOT been run.
- Findings are Refer/Eligible with insufficient documentation.
- Income has NOT been calculated.
- Credit has significant unresolved issues.
- Assets are insufficient or NOT verified.
Pre-approval requests in these cases give the borrower and the real estate agent a false sense of confidence.
MLO Pre-Approval Checklist (AUS-Focused).
The following requirements must be met before a pre-approval letter is issued.
- Completed loan application (1003)
- Credit report assessed
- Calculated and documented income
- Verified employment history for the last 2 years
- Down payment and reserve funds verified.
- AUS findings recorded (DU or LP)
- Conditions in the AUS findings were assessed
- DTI is within program restriction
- No undisclosed obligations or concerns
- Compensating factors identified (if required)
All requirements met, and AUS is Approve/Eligible? You are ready to issue a pre-approval.
If not, take the necessary time to address the issues to avoid concerns later.
Final Thought
AUS should be leveraged as the strong resource it is, but AUS is only as good as the input. A great MLO uses AUS and other resources at their disposal, validates, documents, and verifies each piece they work with prior to issuing a pre-approval letter.
You ensure the best experience for all parties involved by taking the time to do it right the first time, and you protect your personal reputation by preventing any fallout from a soured deal.
Follow-up focused on manual underwriting guidelines and compensating factors is also a possibility, of course.
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