Loan Underwriting: Know what it means, its types and standard rules

A loan underwriting is an important part of the loan process. It helps lenders get a clear picture of the creditworthiness of borrowers and their repayment ability. With the help of credit underwriting, lenders also determine the loan amount as well as other loan terms, including interest rate and tenure for an applicant.

Typically, lenders request various documents and details to initiate the process. Thankfully, technological advancements in the financial sector have helped automate this entire process. Read on to learn what is underwriting, its types and more.

What is Loan Underwriting?

Underwriting is a process through which lenders evaluate your creditworthiness when you apply for a loan. By approving loans to individuals or businesses with a high probability of repayment, this process helps decrease credit risk for lenders. This way, lenders are able to set benchmarks for the loan amount and the premium (interest rate) they should charge for the associated risk. 

Different Types of Loan Underwriting Processes

Here are various types of loan underwriting processes you must be aware of.

Manual Underwriting

Manual underwriting includes physical inspection of the documents and collateral. Lenders use this type of underwriting process for complex and large loan applications. In such cases, lenders review your financial documents, income and other information manually.

Lenders may also assess your application manually if you are a first-time loan applicant and do not have a credit history. 

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Automated Underwriting

Automated underwriting, as the name suggests, relies on technology to evaluate your loan application. It uses a technology-driven approach that includes Machine Learning, Artificial Intelligence, etc. 

It determines your qualification for the loan in minutes by considering information like your income and employment, debt-to-income ratio and quality of the collateral and other details.

Rules and Standard Requirements for the Loan Underwriting Process

Now that you are aware of the loan underwriting meaning, check out the standard requirements and rules for the credit underwriting process.

Income and Employment

Lenders check your income and employment during the underwriting process to evaluate your financial health. They request your salary slips, income tax returns and other financial documents. This gives them an idea of your income and affordability. 

They also check your employment details, including your position, company and work experience. With this information, they assess your employment stability before approving your loan.

Credit History

Your credit history, including your credit score, reflects your borrowing behaviour and experience with credit. Thus, the lenders assess your credit report, which typically includes your credit score from a credit bureau. 

It includes your active credit accounts, outstanding dues, loan settlements, etc. This report allows them to check your creditworthiness through past repayment behaviour for loans, credit cards and more.  

Debt-to-Income Ratio

This is yet another element that lenders assess during the underwriting process. It is the proportion of income you spend on repaying credit. A higher debt-to-income ratio reflects high reliance on credit and gives the impression that timely repayment of a new debt may be difficult for you. So, lenders check it to ensure you can handle repayment on time. 

Investment Paperwork

The credit underwriting process also includes an assessment of your investments. Lenders ask for your investment paperwork, including your investment certificate, in case you offer your investment as collateral for the loan. 

With the investment documents, they calculate the potential returns that you can get. Along with that, they also consider the maturity date of the investment. 

Condition of Collateral

If you apply for a secured loan, you provide collateral as security. Lenders have the legal right to sell your assets to recover their dues if you default on repayment. Therefore, they check the condition and value of your collateral before approving your loan application. 

A few examples of collateral include home, gold, car, etc. In the case of property, they check its locality, value, age and overall condition. If you offer gold, lenders assess its purity and the current gold rates. 

Credit Appraisal

Once the initial steps of the process conclude, lenders move on to credit appraisal. In this step, they determine the loan amount that you qualify for. They may approve a higher loan amount if you demonstrate a healthy credit history, a stable income and employment and a low debt-to-income ratio. A healthy financial profile can also help you get lower interest rates on your loan. 

Keeping in mind the growing challenge of fraud and default, a loan underwriting process offers lenders a way to reduce the risk of non-repayment. This process can take anywhere from a few hours to a few days. To make the process quick, make sure you provide all the vital information and documents. 

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FAQs on Loan Underwriting

What is loan underwriting?

A loan underwriting refers to the risk evaluation process that financial institutions carry out to assess your creditworthiness and the probability of loan repayment. It helps them reduce credit risk.