Underwriting is one of the most important real estate transactions to understand when buying and selling real estate. It’s also the most complex and least understood step of the loan qualification process, so we’re going to simplify it for you.
What Is Underwriting
The term “underwriting” was coined by Lloyd’s of London in the 17th century when wealthy individuals issued coverage for risky ventures like sea voyages. Each risk-taker signed a description of the venture and the total risk amount they were willing to accept in exchange for a lucrative premium — they were underwriting their own risk of shipwreck, mutiny, or other natural disaster.
Today, underwriting assesses the risk you may pose to your lender if you default on your mortgage. In a real estate transaction, underwriting simply means verifying the following information to enable the lender to approve your loan:
- Your income
- Your assets
- Your debt
- Your property details
Straightforward though that may sound, it can require some detailed research and persistent document requests for employers, banks, and municipal entities. So, lenders entrust this task to a financial specialist called an underwriter, who examines your finances and assesses how much risk a lender may take on if they decide to offer you a loan.
Once they assess the risk you may pose, they determine an acceptable level of risk for your lender to take which would make you eligible for loan approval. “What makes underwriting so challenging is that each loan is unique. Every person’s credit profile, work history, and financial situation is different. Underwriters must utilize a variety of information to determine if all aspects of a person’s application and the property meet very detailed requirements,” explains Family First Funding’s Underwriting Manager, Jennifer Minnich. That’s why experience matters — and so does your cooperation.
Though underwriting occurs behind the scenes, your speedy submission of any documents your lender requests is critical to your loan approval. You may be asked:
- Where certain bank deposits came from
- To provide proof of additional assets you may not have mentioned
- To provide updated pay stubs
- To list the total number of employers you’ve worked for in recent years, including part time side jobs
- To ask your CPA for a letter detailing self-employment earnings
All these seemingly minute details can help paint a positive risk profile of you as a borrower and encourage the lender to grant you a larger loan at a better interest rate.
THE ROLE OF A REAL ESTATE UNDERWRITER
Underwriters are fact-checkers who assess your creditworthiness as a buyer. Along with your credentials, a real estate underwriter must calculate the value of the real estate to determine the loan’s security and risk level. If the risk level turns out to be too high, the underwriter may ask that you provide a larger down payment or pay a higher interest rate to cover the increased risk you may pose to your lender.
Your underwriter must answer two questions to determine whether you’re a “good risk”:
- Can you be trusted to make loan payments on time, and meet the loan’s terms and conditions?
- Is the property you’re buying worth the loan amount in case you default and the bank needs to take it back and resell it?
The underwriter must assure lenders that they’ll always have a way of making their money back.
THE TOOLS OF THE UNDERWRITER IN REAL ESTATE
Along with checking the truthfulness of your application, underwriters use two main metrics to research whether and how much financing you should receive:
- Debt Service Coverage Ratio (DSCR) — the relationship between your net operating income and your total loan amount
- Collateral — securing the loan requires a down payment in the amount of the difference between the appraised value and the market value
These metrics help determine how high your interest rate will be and how much you’ll pay for insurance to make the lender comfortable assuming any risk you may pose. To rate you as a borrower the underwriter will also analyze your credit scores from the three main credit bureaus: Equifax, Experian, and TransUnion.
When presented together this research represents the amount of funds you have in reserve, your employment history, and your ability to repay the loan on time and in full.
REVIEW: YOUR UNDERWRITING CHECKLIST
The underwriting process can take anywhere from a few days to a few weeks, depending on the complexity of your real estate transaction.
Here are the basic steps your real estate underwriter will take before approving your loan:
- Review your assets and liabilities to verify income and net worth
- Research your revolving and non-revolving credit line payment history — whether you paid in full and on time
- Pull your credit scores from Equifax, Experian, and TransUnion
- Analyze your debt-to-income ratio (DTI)
- Appraise the property you’re buying to determine its market value
- Do a title search to find the current owner and any liens on the property
- Determine whether the property is in a flood, hurricane, tornado, or other natural disaster zone
- Request additional information from you if needed
The best thing you can do to prepare for underwriting? According to Jennifer Minnich: “Be ready to provide credit, income, and asset documentation and be aware that you may need to explain your unique situation so that we can better understand your application. Also, keep your lender informed of any changes to your credit or employment during the mortgage application process.”
Our team is here to help guide you through the process! To learn more about underwriting, reach out to our team today!
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