Underwriting is one of the most crucial components of the mortgage process that dictates whether or not you’ll get final loan approval. Let’s take a closer look at underwriting and see how it works.

What Is Underwriting?

Underwriting is the process in which your lender verifies your assets, debt, income, and property details in order to issue final approval on your loan application.

While underwriting occurs behind the scenes, it doesn't mean you won't be involved. Your lender could ask for additional documents and answers, such as where bank deposits came from  or proof of additional assets.

What Does An Underwriter Do?

When your future home undergoes an appraisal, a mortgage underwriter examines your finances and assesses how much of a risk a lender has to take if they decide to give you a loan.

The underwriter helps mortgage lenders decide whether or not they will approve your loan and will work with you to make sure that you submit all your paperwork. Ultimately, the underwriter will ensure you do not close on a mortgage you cannot afford. If you do not qualify, the underwriter may deny your loan application.

Underwriters can:

• Examine your credit history. The underwriter analyzes your credit score and pulls your credit report. Among other things, they check your credit score for things like late payments, bankruptcies, and overuse of credit.
• Request an appraisal. Your underwriter will order an appraisal to ensure that the amount the lender offers on the house matches the home’s actual value.
• Verify your employment and income. Underwriters will ask you to provide proof of income and employment.
• Take a look at your debt-to-income ratio (DTI). Your DTI is a percentage that shows lenders how much money you spend versus how much income you make. In order to ensure that you have more than enough cash to cover your mortgage payments, taxes, and insurance, an underwriter examines your debts and compares them to your income.
• Verify how much your down payment is and how much you have saved. In addition, the underwriter will examine your savings accounts to determine whether you have enough to supplement your income or to use as a down payment.

How Underwriting Works

The underwriting process involves conducting research and assessing the degree of risk each applicant or entity brings to the table. This check helps to determine fair borrowing rates for loans, establish appropriate premiums to effectively cover the true cost of insuring policyholders, and create a market for securities by accurately pricing investment risk. Underwriters may refuse coverage if the risk is deemed too high.

Risk is the primary consideration in all underwriting. When it comes to a loan, the risk involves whether the borrower will repay the loan as agreed or will default. In insurance, the risk involves too many policyholders filing claims simultaneously. In securities, the risk is the possibility that the underwritten investments will not be profitable.

Underwriters evaluate loans, particularly mortgages, to determine the likelihood that a borrower will pay as promised and that enough collateral is available in case of default. As for insurance, underwriters seek to assess a policyholder's health and other factors and spread the potential risk to a large number of people. Underwriting securities, usually done via initial public offerings (IPOs) , determines the company's underlying value compared to the risk of funding its IPO.

Types of Underwriting

Generally, there are three types of underwriting: loans, insurance, and securities.

Loan Underwriting

Every loan undergoes some form of underwriting. In many cases, underwriting is automated and involves appraising the applicant's financial records, credit history, and the value of any collateral offered, along with other factors that depend on the purpose and size of the loan. You can expect the appraisal process to take anywhere from a few minutes to a few weeks, depending on whether the appraisal requires a human being to be involved.

The most common type of loan underwriting that involves a human underwriter is mortgage. It is also the type of loan underwriting that most people encounter. Depending on an individual's financial situation, the underwriter evaluates the income, savings, liabilities (debt), credit history, and more. Mortgage underwriting often has a “turn time”  of a week or less.

In many cases, refinancing takes longer because buyers who face deadlines get preferential treatment. Though loan applications can be approved, denied, or suspended, most are “approved with conditions,” which means the underwriter wants clarification or additional documentation.

Insurance Underwriting

For insurance underwriting, the focus is on the potential policyholder—the person looking for health or life insurance. In the past, medical underwriting determined how much to charge an applicant based on their health and even whether to offer coverage at all, often based on pre-existing conditions.  Beginning in 2014, under the Affordable Care Act, pre-existing conditions could no longer serve as a basis for denying coverage or placing restrictions on coverage.

Life insurance underwriting evaluates the risk of insuring a potential policyholder based on their age, health, lifestyle, medical history, family occupation, hobbies, and other factors determined by the underwriter. Life insurance underwriting can result in approval—along with a range of coverage amounts, prices, conditions, and exclusions—or outright rejection.

Securities Underwriting

Securities underwriting, which aims to determine the risk and the appropriate price of particular securities—most often related to an IPO—is performed on behalf of a potential investor, usually an investment bank. Investment banks buy (underwrite) securities issued by companies attempting IPOs and then sell those securities on the market based on the results of the underwriting process.

Underwriting ensures that the company's IPO will raise the capital required and provides the underwriters with a premium or profit for their service. Investors benefit from the vetting process that underwriting offers and its ability to make an informed investment decision.

This type of underwriting can involve individual stocks and debt securities, including corporate, government, or municipal bonds. Usually, underwriters or their employers purchase these securities and resell them for a profit either to investors or dealers (who resell them to other buyers). When more than one underwriter or a group of underwriters is involved, they are known as an  underwriter syndicate.

How Long Does Underwriting Take?

The time frame for underwriting varies among investment products, as the underwriter will have to spend some time reviewing the risk profile of each investment. Personal loans and insurance products are generally simple to underwrite.

Personal Loans

A computer algorithm manages the loan process for car loans; it compares an applicant's profile with that of other borrowers. This process takes only a few days at most, and in some instances, it is almost instantaneous.

Home mortgages tend to take longer because the underwriter will need to verify the borrower's employment, income, and credit history, which can take some time. Full approval for a home loan can take up to 45 days, although the underwriting process itself accounts for only a tiny portion of it.

Insurance

Underwriting insurance is similar to underwriting a loan, except that the insurers weigh the size and probability of the average claim compared to the premiums they expect to collect. In the case of property and auto insurance policies, this relies on factors like the age of the insured, their geographical location, and their history of making claims.

Life insurance policies are more complicated because they also factor in a person's medical history. The underwriting process for life insurance can also take a month or longer, although most decisions are issued in a few days.

Stocks and Bond Issues

Securities are one of the most complicated products to underwrite. When a company issues a stock or a bond offering, the underwriter (usually an investment bank) reviews the company's accounts, assets, cash flows, and liabilities, and checks for any discrepancies. It can take between six and nine months to underwrite.

What Information Do Underwriters Look at?

Whether they are providing insurance or lending money, underwriters look at the financials of each applicant to determine how much risk they are taking on and the likelihood of losing money. Generally, this is done by comparing historical data. If applicants with a similar risk profile tend to default X% of the time, then the premiums or interest rate will be priced to reflect that probability.

A personal loan underwriter and an insurance underwriter will examine the available data of the applicant. As for loans, they may look at the borrower's income, employment status, and  credit history . In addition, they will assess the value of any assets used as collateral. In the case of life insurance, they might also examine their medical history, including risk factors such as smoking or drinking.

For securities, the underwriters will look at the issuer's financial situation, such as their income statements, debts, cash flow, and any other potential liabilities, before pricing a stock or bond issue. Furthermore, they will examine the issuer's credit rating, which corresponds to a consumer's credit score.

How To Have The Best Underwriting Experience

In most cases, your lender handles the underwriting process for you. You can, however, take a few simple steps to ensure you have the best experience.

Tip #1: Do Not Apply For Any New Credit Lines During Underwriting

Any significant financial changes and spending may cause complications during the underwriting process. A new line of credit or loan could interrupt this process. Also, avoid making any purchases that could deplete your assets. Upon receiving the underwriting decision, you can then proceed with your purchase.

Tip #2: Respond To Inquiries As Soon As Possible

During underwriting, your lender may contact you and request additional bank statements, financial documents, or other proof of assets or income. Respond to these underwriter requests as quickly as possible. Your underwriter won't be able to proceed or approve your home loan without them.

Tip #3: Be As Upfront And Honest As You Can About Your Finances

Your underwriter will know if you’re lying about your income, credit history, or assets, so there’s no use hiding any information. Instead, include notes and explanations for things that stand out on your credit report or statements.

The Bottom Line

Underwriting involves examining a loan application or insurance application to determine the level of risk it presents to a lender or insurer. Usually, this involves checking the applicant's income, assets, and credit history to see if they will end up costing the underwriting institution more than they pay.