What is Loan Underwriting? Explaining the Underwriting Process and Rules
If you are planning to get a loan, you need to learn about loan underwriting. Underwriting is a behind-the-scenes process. It is the most crucial step in acquiring a loan. The underwriting process takes place for all types of loans, whether you apply for a personal loan, a home loan, a car loan, or any other kind of loan. Understand the underwriting process and the rules that guide the decision to prevent rejection.
What is Loan Underwriting?
The underwriting process is an assessment of your creditworthiness by the lender. The idea of credit underwriting is to determine whether you meet the eligibility criteria for a loan.
Here, the lender assesses your income, debt, assets, and other financial details. They further categorize the findings into three C’s:
- Collateral.
- Capacity.
- Credit.
Based on these 3 determiners, the lender establishes whether you can pay the loan. Loan underwriting is important to secure the interest of both parties, the lender and the borrower.
Underwriting Process
- Prequalification
Prequalification is not a part of the underwriting process. However, this tool can be used by borrowers to get a fair idea of their eligibility for loans. It’s a casual step that gives you a general idea of how much loan to apply for and what interest rates you can afford. Getting prequalified could mean that if you were to apply formally, you could likely get a loan.
- Pre-approval
Pre-approval is an important part of the loan underwriting process. This step will determine the maximum loan amount that can be offered to you. Here, a lender will evaluate various financial documents and run a credit check. After a thorough evaluation, the lender will determine the loan amount and its interest rate.
To get the pre-approval process started, the lender would require certain financial information.
- Make a formal loan application and offer financial documents. The financial documents include income proofs, debts, savings, credit scores, and other loan information.
The lender verifies the information and makes important decisions based on it. The documents submitted should reflect true information. If not, your application will be denied.
- Income and asset verification
The most crucial part of the underwriting process includes the verification of income and other financial proofs. The only reason for this check is to make sure that you can pay back the loan with your current income.
The income and asset verification includes a detailed study of your tax returns and bank account statements. The asset study includes the balance in your account, investments, retirement savings, stocks, and much more.
If the lender finds your income and asset proofs adequate, they will issue the preapproval letter. A pre-approval letter is an indication that you could obtain a loan.
However, this still doesn’t imply that your loan application is accepted. There are further steps to determine that.
- Appraisal
In the case of home loans, this is the most important aspect. The underwriter examines the value of the home you are planning to buy. Here the sale price of the house is verified with the fair market value. This is done so that lenders don’t end up paying more than the worth of the house. The appraisal step rules out the chance that you save loan amounts by buying cheaper homes.
- Title search and insurance
A title search ensures that the property can be transferred. This will prevent the lender from lending money on a house that has legal claims on it.
The property history, liens, claims, pending legal actions, mortgages, and other aspects are assessed. The title company then offers insurance to ensure the accuracy of its research.
- Final decision
The entire underwriting process will lead to the decision of whether to deny, approve, or suspend the loan application. The loan application can be rejected if the lender doesn’t find you suitable enough for the loan. They can suspend the application if a few documents are found missing. However, you can reactivate the application again by submitting the required documents. If approved, the lender will finance your loan.
Rules that Guide Loan Underwriting Decisions
- Credit score
A high credit score establishes the fact that you are credible. It reflects your history as to how regular you have been in paying your loans. A credit score is a very important factor affecting the loan underwriting decision. A recommended credit score will help you get a loan at competitive rates.
If you are applying for loans, a credit score of 750 or above makes a good start.
- Income
Income is the cornerstone that establishes whether you can repay the loan. Lenders determine the income level below which they won’t approve a loan.
- Collateral
To avail a loan, you need to pledge assets that can act as collateral. Collateral is required for nearly all kinds of loans. In cases of default, collateral is used to repay the loan.
The value of the collateral is very important. It should ideally be higher than the loan amount to serve the required purpose.
- Debt and liabilities
Don’t apply for new loans while the underwriting process is going on. Your current debts and liabilities are assessed to ensure that you can still repay the new loan. The lender needs to ensure that you can repay the loan with your current debts.
Ideally, your total debts should not be more than 30 to 35% of your income.
Final Takeaway
Underwriting is not to be feared. It’s a friendly process. All you need to do is understand the basics that guide the underwriting process and adapt accordingly. With sorted fundamentals, the underwriting process will only get easier.
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