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. Character – 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.



Character – Character refers to the creditworthiness 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 a borrower owes and his or her payment history is one objective, several subjective elements are considered to determine the credit score of an individual, such as if the total account balances are 75% or more of the credit limit, which would indicate a high financial leverage and create a higher risk to the lender. A large number of open accounts with zero balances can also lower the credit score because it increases the potential for future excess debt and ability to service the loan debt. Most lenders who sell their loans into the secondary market use the following parameters when evaluating credit scores:

  • Scores above 720: Borrowers will receive better terms and interest rates on their loans.
  • Scores between 680 and 720: credit risk is good and can help compensate for other risks in the borrower profile.
  • Scores between 620 and 680: comprehensive review to look for potential risks.
  • Scores below 620: cautious review required; borrowers may find themselves locked out of the best loans and terms available.

The Fair Credit Reporting Act (FCRA) requires credit reporting agencies to give a borrower a copy of their credit report at no charge if a borrower is declined for a loan. Borrowers who have not been declined can also receive a copy for a nominal charge. Further, the reporting agencies must verify and correct any errors in a credit report when the borrower advises them of an error. Also, borrowers have a right to include a statement of explanation for derogatory information in their credit report. It is advisable for real estate agents to include a frank discussion as to whether there is any derogatory credit information and emphasize the value of cleaning up a credit report before making a loan application.

Capacity – Capacity refers to the borrower’s ability to repay or service the loan, with emphasis 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 31%. 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 will allow up to 43%, and VA allows up to 41%. If a borrower qualifies comfortably on one of the ratios, a lender may allow a little leeway on the other.

The lender also considers the employment history of the borrower. 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 the probability of continued employment. Another factor considered by the lender is the net worth of the borrower. To determine net worth, the lender will subtract borrower liabilities from borrow assets (Assets-Lisbilities=New Worth). Fannie Mae regards “an accumulation of net worth as a strong indication of creditworthiness.” 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 – Collateral refers to the value of the property being purchased, which will be 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 underwriter evaluates the collateral and the borrower, a summary of their evaluation is sent to a loan committee. The loan committee makes the final decision on whether to approve the loan. If the committee approves the loan, they will issue a loan commitment letter to the borrower. This commitment letter is a written agreement by the lender to make the loan, subject to any specific terms and conditions listed in the letter.

Note: Qualifying ratios and credit score parameters change based on economic conditions. Always check with your qualified mortgage professional for the most current information for today’s market conditions.


OnlineEd blog postings are the opinion of the author and not intended as legal or other professional advice. Be sure to consult an appropriate party when professional advice is needed.

For more information about OnlineEd and their education for real estate brokers, principal brokers, property managers, and mortgage brokers visit

All information contained in this posting is deemed correct as of the date of publication, but is not guaranteed by the author and may have been obtained from third-party sources. Due to the fluid nature of the subject matter, regulations, requirements and laws, prices and all other information may or may not be correct in the future and should be verified if cited, shared or otherwise republished.

OnlineEd® is a registered Trademark