To underwrite a loan means to assess how much risk a mortgage lender is willing to take on when they lend money to a borrower. Mortgage underwriting is a meticulous and systematic analysis of borrower variables to assist financial institutions like lenders and banks determine whether the risk posed in providing a loan. The risk of defaulting associated with the mortgage loan is calculated by considering 3 key factors: credit, capacity, and collateral. It is through the underwriting process that a borrower finds out whether their mortgage loan has been approved or denied. To understand what underwriting a loan means, why don’t we take a more detailed look into its various facets.

Underwriting Evaluates Credit

Loan underwriting requires verifying whether the borrower’s credit accounts, bankruptcies, collections, and credit scores fall within the desirable range. How well a borrower manages their past or current debt is usually an accurate measure of how they will manage their future debts. Underwriter obtain credit reports from each of the 3 credit bureaus: Experian, Equifax, and TransUnion and tally them. These reports provide the underwriter with insights into the borrower’s history with credit cards, late payments, collections, delinquent accounts, loans, bankruptcies, and judgments. Often, the borrower’s credit history is highly correlated with the probability that the borrower will default on their mortgage loan by failing to make their monthly payments.

Underwriting Evaluates Capacity

Mortgage underwriting also entails looking into the borrower’s ability to make the loan payments by investigating their cash reserves (liquid assets), current debt, employment history, income, assets, tax returns, payslips, and their debt-to-income ratio (DTI). The DTI is a measure of how much outstanding debt the borrower has in comparison to their gross income. Typically, lenders do not consider DTIs that exceed 43%. Assets can include the borrower’s savings and checking accounts, their 401K, and any investments they have to their name from mutual funds to stocks. Any pensions and personal property that tend to lack liquidity are not considered assets and may not be used in these calculations.

Underwriting Evaluates Collateral

Underwriters look at the property in question, its appraisal value, the down payment amount, and how much the borrower is looking to borrow before making their decision. However, the value of the home is the most important characteristic. It is derived from the appraisal value of the property, which depends on the recent sales of properties in that neighbourhood with similar characteristics. The appraisal value is used to calculate the loan-to-value (LTV), which is the ratio of the loan amount to the value of the new home. The higher the LTV, the greater the risk involved. Additionally, borrowers who contribute larger down payments tend to face reduced risks of defaulting, making the underwriter’s decision that much easier.

Once an underwriter has factored in credit, collateral, and capacity completely, an underwriting decision is made. The loan underwriting decision may be approved, suspended, or denied. In the case that the loan is suspended, additional documents are usually required to move that decision towards an approval. Because underwriting can be a complex task, it is usually wise to entrust the mortgage underwriting process to mortgage outsourcing professionals to ensure that all the loan criteria are met, and all the relevant risks are mitigated.