If you’ve ever applied for a loan, such as a mortgage, it’s safe to assume that you’ve come across the financial term “underwriting” at least once.
While this is a big part of the loan process, you may not fully understand the finer details of underwriting, including what it entails.
There is a lot to learn about underwriting, but the basic definition may be all you need in order to get in the right frame of mind to apply for a loan.
Generally speaking, underwriting is the process a lender uses to determine if the risk of offering a loan to a borrower is acceptable, according to Investopedia.
There are three possible outcomes:
- The underwriter approves the loan, and the lender takes on the risk
- There are red flags, which could result in the denial of your application
- The underwriter could request additional information to help him or her make a more informed decision
Although every lender has its own underwriting process, most focus on three primary areas: capacity, collateral, and credit (more on this below).
Underwriters may have a strict set of guidelines, that also could be accompanied by a computer model, to analyze the loan and the risks of lending money to the borrower.
The Process Differs by Loan Type
While the basic definition of underwriting remains the same from one type of loan to the next, the actual process can and will differ. For example, underwriting a personal loan is not the same as a mortgage.
In the case of a personal loan, according to Investopedia, underwriting involves the following:
- Examining the credit history of a borrower
- Considering the risk of a default on the loan
Underwriting is also used in the insurance industry, as underwriters have to analyze the risk of something happening to a home or a building. It also comes into play in investment banking, for instance, when bankers are rolling out an initial public offering of a stock.
The mortgage underwriting process is among the most involved, as it usually includes all of the following steps (among others):
- Review of your personal finances. This includes your capacity to make payments, collateral (which is not required for personal loans), and credit.
- Appraisal. The lender wants to know if the purchase price of the home is in line with the value of comparable properties in your area.
- Title search and insurance. A title company is staffed with the responsibility of reviewing the legal history of a property.
As compared to a mortgage, underwriting of a personal loan can be fairly simple if borrowers meet the lender’s criteria.
Stay Involved Throughout
Regardless of the loan type, you should remain part of the underwriting process from start to finish.
Let your lender know that you are available to answer questions and provide additional documentation if required. This can go a long way in pushing the process forward, while also decreasing the chance of a delay.
You may not need to understand all the details of the underwriting process, but knowing the basics will allow you to efficiently move forward one step at a time.