There are many kinds of risks involved when getting a loan. For both borrower and lender. Which is why it is usually seen as a last resort to things.
One of the things involved in the process of taking out a loan is underwriting. But what does an underwriter do? And what is the underwriting meaning?
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What is a Loan Underwriter?
A loan underwriter assesses the lender’s risk of lending money to you. The main task for a lender besides lending you the money is to determine whether you would be able to pay back the home loan. This is done before your application is processed. If you seem like too much of a risk or do not have the ability to pay back the loan, your application is not accepted and you are not granted the loan you came for.
A loan underwriter collects many documents that are needed for your application. They also verify your identification, check any credit history and assess your financial situation. This includes your income, cash reserves, equity investments, financial assets among other risk factors.
Loan underwriters look at three main factors that are often referred to as the three C’s:
1. Credit: Your credit history is valuable for a lender to make their decision. It will show how you have handled credit in the past. Moreover, an underwriter also looks at credit reports for any negative information. For example, if you are in a state of bankruptcy, experienced a foreclosure or have been delinquent on a loan, whether it be on a mortgage or a credit card, it would make you a risky borrower.
Having a good credit history overall will just improve the chances of your application getting accepted. It might also help you qualify for more favourable terms like lower interest rates and down payment requirements.
2. Capacity: Even if your credit history is good, your loan underwriter would want to know if you have the ability to make your monthly payments. When looking at capacity, the most important things for a loan underwriter are your income and other debt payments.
Loan underwriters not only look at where you stand today but they also consider your ability to pay this additional debt. They also consider what will happen after you close and still have a mortgage payment to maintain.
You can determine your financial capacity by calculating your debt-to-income ratio which is the sum of your monthly debt payments divided by your gross monthly income. To have an idea of what is good, your monthly housing payment should not be more than 28% of your gross income and your total debt-to-income ratio should be at 36% or less. However, if you choose to, you can get a conventional loan with a debt-to-income ratio that is up to 50%.
Loan underwriters are also likely to consider other factors such as how many people are on the loan, how much cash you will be left with after making the down payment and paying the closing costs and whether you are self-employed or receive a salary.
3. Collateral: When loan underwriters are assessing the risk, not only are they evaluating you but also the property you want to buy so they can ensure it meets their standards. Some loan programs also require that the property meet certain safety standards. The loan amount is also required to not exceed the program maximum.
Lenders also want to ensure that the appraised value of the home should be enough for them to recoup its costs if you start defaulting on your payments.
Other factors that are considered under collateral are the type of property it is, your down payment and what purpose will the home serve. For example, will you be using it as a primary residence or a second home or are you buying it for investment purposes?
The loan underwriting process starts with gathering information. This is done when the applicant submits their initial loan request. Lenders ask for the borrower’s personal information like the borrower’s identity, income, employment status, residential history, financial investments and debts. Copies of credit reports, recent tax returns, bank statements, any government-issued identification and paychecks may also be requested by lenders.
All of this information then goes through official verification and begins the second phase of underwriting. This information is then verified either manually by the underwriter or put through computerized data systems. If you have any outstanding debt balance or payment histories, they would be verified by phone calls to your bank. Your credit reports are also likely to be checked for any indications of financial instability.
Once all the information has been verified, an appraisal of the property along with an inspection is ordered by the lender. This appraisal is to ensure that the money being lent out is not more than the property’s current market value and the inspection is to ensure that the property is in good condition.
The seller may have to reduce the agreed upon sale price if the property appraises at a lower value in order for you to have the lender’s approval. These changes to the sale agreement would have to be made between the seller and buyer’s realtors before the underwriting process will proceed further. However, if the inspection turns up with issues such as plumbing and roof leaks that might end up lowering the value of the property, they would have to be checked and taken care of before the lender approves the loan.
The last step of the underwriting process would be to analyze all the information provided by you. Loan underwriters have to consider from the lender’s perspective if extending the loan will make financial sense for the. This could be done with the help of the debt-to-income ratio analysis that will help lenders in determining the percentage of the borrower’s gross monthly income that will be required to make the loan payment. If the bank decides that extending the loan makes sense, they will give the approval for your application.
The duration of the underwriting process mainly varies depending on your lender. If your lender is processing a lot of loan applications, the underwriting process can take up to 45 days. However, if your lender is a small bank that does not receive as many loan applications, it is possible to be approved for the loan in only a short span of time.
Types of Underwriting
There are three types of underwriting and loan underwriting is just one. The other types are:
1. Insurance underwriting, which focuses on the potential policyholder which can be any person looking to buy health or life insurance.
In the past, medical underwriting was only used to determine how much a person should be charged based on their health and whether to even offer coverage at all if the applicant has some significant pre-existing health conditions. However, after 2014 under the Affordable Care Act, insurers could no longer deny coverage or impose any kind of limitations based on any pre-existing conditions.
Life insurance underwriting assesses the risk based on a potential policyholder’s age, health, lifestyle, family medical history, hobbies, occupation and other factors. However, unlike health insurance, it is not restricted to health factors of any pre-existing conditions. Life insurance underwriting usually results in approval with different ranges of coverage amounts, prices and conditions. However, it is also not impossible to be rejected.
2. Securities underwriting, that focuses on assessing risk and the appropriate pricing of particular securities. It often relates to an IPO and is typically performed on behalf of a potential investor such as an investment bank. And based on the results from the underwriting process, the investment banker would buy the underwrite securities that have been issued by the company that is attempting the IPO and then sell those securities in the market.
In securities, underwriting is important because it ensures that the IPO company raises the amount of capital that is needed and also provides the underwriters with either a premium or a profit for their service. Investors usually end up benefiting from the vetting process that underwriting provides them with and the ability it can give them to make an informed decision about their investment.
In the financial market, underwriting can also involve individual stocks as well as any debt securities including corporate, government and municipal bonds. These securities are purchased by underwriters or their employers and then resold for a profit either to dealers who sell to other buyers or investors. An underwriting syndicate is if more than one underwriter or a group of underwriters is involved.
So the answer to the question, “What is a loan underwriter?” is that loan underwriters are people that help assess the risk before making a huge decision concerning whether or not a lender should lend their money to a borrower.
The role of a loan underwriter is a very significant one because they are the ones who determine whether or not lenders will be able to get their loan back and whether the borrower would be able to afford it in the long term.