Chapter 15: Manual Underwriting Guidelines and Exceptions

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While automated underwriting systems (AUS) like Fannie Mae’s Desktop Underwriter (DU) and Freddie Mac’s Loan Product Advisor (LPA) handle the bulk of mortgage loan decisions, some loans require manual underwriting. This chapter explores when manual underwriting is necessary, the guidelines for processing such loans, and how underwriters handle exceptions.

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Section 1: When Manual Underwriting is Required

• Loan does not meet AUS eligibility criteria.
• Borrower has credit issues or insufficient credit history.
• Non-traditional income or complex income sources.
• Loans involving gift funds or unseasoned assets.
• Loans with exceptions such as higher DTI or lower credit scores.
• Non-standard property types or non-warrantable condos.
• AUS fails or system is unavailable.

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Section 2: Manual Underwriting Documentation Requirements

• Full documentation of income, assets, credit, and employment.
• Detailed Verification of Employment (VOE) and Verification of Deposit (VOD).
• Comprehensive explanation letters (Letter of Explanation, LOE) for derogatory credit or gaps.
• Copies of tax returns, bank statements, and other financial documents.
• Supporting documents for any exceptions requested.

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Section 3: Credit Guidelines in Manual Underwriting

• Minimum credit scores may be lower, but typically no less than 620.
• At least 3 trade lines open for 12 months preferred.
• No recent major derogatory events (e.g., bankruptcy within 2 years).
• Address and document all late payments, collections, and judgments.
• Request LOEs to clarify credit issues.

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Section 4: Income and Asset Analysis

• Follow standard income verification but allow for more manual review.
• Assess stability and likelihood of continuance.
• Evaluate non-traditional income carefully.
• Asset verification must be thorough; all large deposits sourced.
• Evaluate reserves as compensating factors for exceptions.

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Section 5: Debt-to-Income (DTI) Ratio Flexibility

• Maximum DTI may exceed AUS limits (e.g., up to 50% with compensating factors).
• Requires stronger compensating factors like higher reserves or lower LTV.
• Each compensating factor must be documented and justified.

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Section 6: Exceptions to Standard Guidelines

Exception Type	Requirements	Notes
Credit score below AUS minimum	LOE, compensating factors	Acceptable on case-by-case basis
Higher DTI (>43%)	Reserves, stable income	Documentation essential
Limited credit history	Alternative credit documentation	Rent payment history, utility bills
Gift funds from non-eligible donors	Additional documentation	Gift source must be verified
Non-warrantable properties	Risk analysis and higher reserves	May require lender approval

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Section 7: Risk Mitigation Strategies

• Obtain letters of explanation for all derogatory or unusual items.
• Require additional reserves or assets to offset risk.
• Tighten appraisal requirements.
• Use mortgage insurance where applicable.
• Higher interest rates or fees may apply.

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Section 8: Manual Underwriting Process Flow

1. Loan file submission to underwriter.
2. Detailed review of all borrower information and documents.
3. Request clarifications and LOEs if necessary.
4. Assess AUS findings (if available) and exceptions.
5. Prepare loan approval conditions with compensating factors.
6. Finalize decision and communicate with loan officer.

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Section 9: Common Challenges in Manual Underwriting

• Subjectivity in decision-making.
• Longer processing times.
• Need for greater documentation and borrower communication.
• Higher scrutiny from investors and secondary market.

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Section 10: Case Studies

Case 1: Borrower with Limited Credit History

• No credit cards or loans.
• Used rent payment history and utility bills for credit evaluation.
• Approved with manual underwrite and compensating factors.

Case 2: High DTI with Strong Reserves

• DTI at 48%, reserves cover 12 months PITIA.
• Stable income and excellent credit.
• Manual underwrite approved with conditions.

Case 3: Gift Funds from Non-Relative

• Gift letter and donor documentation not meeting standard guidelines.
• Additional verification requested.
• Loan approved after donor qualification confirmed.

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Final Notes

• Manual underwriting requires careful, detailed evaluation.
• Proper documentation and risk assessment are critical.
• Always follow investor and agency guidelines strictly.
• Document all decisions and exceptions clearly.

 

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