Mortgage underwriting is the process by which a lender analyses the risk of extending a mortgage loan to a borrower by ensuring that the loan terms are favourable for their business. Underwriting is the stage of the mortgage process that determines whether the mortgage loan is approved or not.
It is important for the underwriter to assess the risk involved accurately in order to cover their losses in the event that a borrower defaults on their loan. The mortgage underwriting process comprises of 5 key steps: verifying credit, collateral, and capacity and assessing home appraisals and conducting title searches for red flags. To get a better understanding of these steps, let’s explore each one in more detail.
Step 1: Get a Home Appraisal
In mortgage underwriting an appraisal is an unbiased report evaluating the fair market value of a home. This value is directly influenced by the recent sales of similar properties in the area and by current market trends. The home’s square footage, number of bedrooms, and amenities are key factors in assessing its value. The general condition and age of the home, the location of the property, and any structural improvements that were made are also considered. Appraisals are ordered by lenders to ensure that the loan amount does not exceed the value of the home.
Step 2: Assess Credit
In the mortgage underwriting process underwriters look to establish whether a borrower manages their current and prior debts responsibly or not through their repayment and credit history. They pull a credit report that contains information such as the borrower’s current and past loans, foreclosures, collections, judgments, tax liens, bankruptcies, and credit card history. In loan underwriting, the borrower’s credit history is highly correlated with the probability that they will fail to make the monthly instalments necessary to repay the loan.
Step 3: Assess Capacity
Underwriters also need to establish whether the borrower actually has the resources with which to make the payments on the loan. They analyze the borrower’s income, employment history, current debts, and current assets to come to a decision. The underwriter will determine the stability of their income by reviewing their employment history. In the underwriting process, self-employed borrowers are the riskiest to lend to as they must be responsible for both their personal finances and the business’ well-being. Borrowers who are employed by a company pose the lowest risk given their job stability.
Step 4: Assess Collateral
Loan underwriting involves assessing the type and value of the property being financed as the home serves as collateral for the loan. Different types of properties carry different risks – with investment properties being the riskiest to finance and primary residences the least risky because a borrower is more likely to walk away from an investment property the moment financial difficulties arise. If the borrower defaults on the mortgage loan, the lender must be able to sell the property to recover their losses, thus making collateral an important step in the mortgage underwriting process.
Step 5: Conduct a Title Search
In loan underwriting a title search is the process of examining public records from tax records and past deeds to other financial transactions linked to the property to ensure that the individual selling the property is the true owner so that it can be legally transferred to the borrower without any complications. Title searches serve to uncover liens or encumbrances on the property that might cloud the title and prohibit the transfer of a clean title. Any judgments or claims on the property need to be exposed before the property can be used as collateral by the lender in the mortgage underwriting process.
The mortgage underwriting process can be tricky to navigate given all the documentation and assessments it involves. Home appraisals play an important role as without them the loan amount cannot be properly validated. Assessing credit, collateral, and capacity are also essential steps in the process as they determine just how well the borrower will be equipped to and able to repay their mortgage loan in the future.
In loan underwriting, conducting a title search is imperative to determine whether the property can in fact be legally sold or not. All 5 steps need to come together to make for a cohesive underwriting process that accurately forecasts the profitability of extending a mortgage loan to a borrower.
Overlooking or eliminating any one step could spell disaster for a lender as their evaluation of the risks involved would not be complete – leading to foreclosures, legal difficulties, and losses long term.
Image credit: Mortgage Underwriting via WSW1985/Shutterstock