Underwriting is a process in which an underwriter assesses the risks associated with a loan or mortgage. The risk evaluation is done to protect banks, investors, financial institutions, and insurance agencies from any loss.
If you’re a real estate student, you might find it challenging to prepare for your exam because of difficult terms. I’m a real estate professional, and I’ve been teaching real estate courses for many years. As a real estate expert, I’m aware of students’ challenges while preparing for the real estate exam. My job is to help such students so that they have a clear concept regarding real estate terms.
In this post, I’ll define underwriting and explain it with the help of examples. After reading this post, you’ll have a clear understanding of the underwriting process of a loan.
What Is Underwriting?
Underwriting is a process that lenders use to know whether the borrower qualifies for a loan. An underwriter evaluates the risk and determines whether the lender should enter into a loan agreement.
For financial institutions, including banks, investors, and insurance companies, any decision can cause damage if the risks are not appropriately assessed. Sometimes these risks can cost a lot; thus, it is essential to understand what the lender will take in the form of risk.
This risk evaluation is done through underwriting, and mostly in-house personnel perform it. During underwriting, the in-house personnel looks at the finances and evaluates how much risk the lender can take if they decide to give a loan.
Underwriter
An underwriter carries out the underwriting process and determines the risk worthiness of a loan. Underwriting is not an easy job as an underwriter must complete an evaluation of the risks that underlie a loan or mortgage. Thus, an underwriter plays an essential role in a financial institution. An underwriter evaluates the mortgage application by reviewing the 4Cs:
- Credit (FICO score)
- Capacity (Debt-to-income ratio)
- Collateral (Property Value)
- Capital (income and assets)
The following are the main responsibilities of a mortgage underwriter:
- Examine the mortgage application
- Assess the income, property, assets, and credit of the borrower
- Apply institution standards
- Conduct investigation and assessment of materials submitted by the borrower
- Accept or reject applications based on assessment and evaluation
Mortgage Underwriting
In mortgage underwriting, an underwriter assesses the financial risk for approving a home loan. Underwriting is a compulsory part of loan approval, without which loan origination doesn’t take place. When lenders receive a loan application, they forward it to an underwriter to determine the risks. During mortgage underwriting, the underwriter checks the borrower’s income, credit history, assets, and overall eligibility.
The underwriter focuses on five primary key considerations to make a decision. These key factors include the borrower’s credit score, affordability, property, deposits, LTV (loan-to-value ratio), income, and maximum loan amounts.
After examining these factors, the underwriter determines the level of risk involved in the mortgage if the lender decides to offer it. Based on the risk assessment, the underwriter decides whether the lender should accept or reject the mortgage application.
How Mortgage Underwriting Works
Mortgage underwriting starts when the borrower submits the mortgage application. It happens behind the scenes, during which the borrower’s financial background and creditworthiness are evaluated. This is done to determine whether the borrower is eligible for the mortgage. The underwriter follows certain underwriting guidelines during the process. The following are the steps in a mortgage underwriting process:
Pre-approval
This is the first step of mortgage underwriting, in which the borrower applies for pre-approval. To pre-approve the borrower for a mortgage, the lender reviews the mortgage application by evaluating the borrower’s profile and basic information.
Financial Review
After the borrower receives pre-approval for a mortgage, their application goes through a financial review. An underwriter reviews the borrower’s finances for income and asset verification during the financial review. They will look at the borrower’s credit score, debt-to-income ratio, employment history, income, and assets. The underwriter finds answers to these questions:
- Does the borrower have a stable employment history?
- How well has the borrower managed their credit?
- Is the borrower able to repay the loan?
- Is the property’s value supportable by the loan?
Appraisal
The underwriter will order a home appraisal if the above evaluation is clear. During the appraisal, the underwriter evaluates the property value and ensures that the mortgage is not greater than the property value. The value is determined by evaluating the age and size of the house by comparing other homes in the locality.
Title Search
The title search of a property includes assessing and evaluating the property if it has any claims or liens. The property should be free of any outstanding claims to be eligible for a mortgage. The property shouldn’t include any unpaid taxes or judgments.
Underwriting Decision
This is the final step of the underwriting process, in which the lender decides whether to approve or reject the loan. After reviewing the mortgage application thoroughly and evaluating the risks, the underwriter makes a decision. If the mortgage application is denied, the borrower will not get a loan for purchasing the property. If the mortgage application is approved, the lender proceeds toward loan origination and issues a clear to close for the loan.
Underwriting Example
John submits a mortgage application at a bank for purchasing a property. The lender had a brief look at the mortgage application and pre-approves it. They forward the mortgage application to their underwriter to assess risk. The following are the details of John’s financial profile:
- Credit score: 740
- Monthly income: $5000
- Debt to income ratio: 33%
- Loan-to-value ratio: 40%
- Ability to pay down payment: 30% of home price
After reviewing John’s financial profile, the underwriter decides that there is no risk involved in the lending process. The lender approves the mortgage so that John can purchase the property easily.
Frequently Asked Questions
How Long Does Underwriting Take?
Mortgage underwriting can take a few days or a few weeks. If the underwriter requests additional information, it might take a few weeks. It also depends on how busy the lender is and the type of mortgage.
The earlier the borrower compiles the information and provides it to the lender on their request, the speedier the underwriting process is. Remember that underwriting is an initial process in lending, and together with loan origination, it might take around 40 to 50 days till mortgage approval.
Can a Loan Be Denied in Underwriting?
Yes, a loan can be denied in underwriting. Before approving the loan, the lender verifies the credit score, income, assets, and debt. If the borrower doesn’t meet the lender’s requirements, they can deny the loan in the underwriting process. The following are the reasons for which a loan can be rejected:
• Bad credit score
• Unstable income
• Higher amount of debt
• Low funds to close the loan
What Does Underwrite Mean for Mortgage?
A mortgage underwriter carries out the underwriting for the mortgage. They evaluate the risk associated with the mortgage and decide whether it will be a good decision to offer a mortgage to the borrower. An underwriter has a big responsibility for a mortgage because they are the one who convinces the lender to accept or deny a mortgage.
What Happens During the Underwriting Process?
During the underwriting process of a mortgage application, all the information the borrower provides is assessed. An underwriter examines credit reports, mortgage applications, bank statements, proof of income, proof of deposit, and property details. After evaluating all the information, the underwriter determines the degree of risk associated with the mortgage. Then they decide whether to accept or reject the mortgage application based on risk assessment.
What to Know for the Real Estate Exam
Underwriting is a process in which an underwriter evaluates the borrower’s mortgage application and financial profile to determine the degree of risk. This is an important part of the lending process, especially for the lender. During underwriting, the decision to accept or deny a mortgage is made. An underwriter assesses the risks and decides how much risk the lender will take if they accept the mortgage.
I hope this post helped you understand the underwriting process and the role of an underwriter for a mortgage. If you want to learn other real estate terms, go through this extensive collection of real estate definitions.
