Loan Underwriting: Meaning, Process and More

Once you apply for a loan, the request undergoes several verifications before getting approved. This is because handing out a loan involves a significant amount of risk for lending institutions. They take into account various factors related to the borrower's financial history to gauge this risk of lending money to the borrower.

The process of verifying all this financial information is known as loan underwriting. In this blog, we'll dive deeper into the meaning and significance of loan underwriting; read on as we discuss what it is and the factors it considers to finally issue the approval.

Let's get started!

Purpose of Loan Underwriting

The underwriting process minimises risk on the lender's end. Post-Loan Underwriting: Meaning and Understanding evaluation, the loans are granted to individuals or businesses who are most likely to repay the amount on time. Essentially, underwriting is for the lender to gauge the amount of risk they should take in exchange for a premium, which is the interest rate. The higher the risk, the higher the interest is likely to be. If the risk is deemed to be too high, the loan gets rejected.

Types of Loan Underwriting

Depending on the type of the loan being availed, loan underwriting can be categorised into different types. Following are some of the most prominent types of loan underwriting:

Personal Loan Underwriting

Personal Loan underwriting involves assessing an individual’s financial health, including credit score, income, employment stability, and debt-to-income ratio (DTI). Since personal loans are unsecured, lenders rely heavily on the borrower’s creditworthiness.

Business Loan Underwriting  

Business Loan underwriting evaluates a company’s financial statements, cash flow, business credit score, and collateral (if applicable). Lenders assess the business’s ability to repay based on revenue trends and profitability.

Mortgage Underwriting

The mortgage underwriting process is for home loans or for a Loan Against Property. Since these loans are secured, the property acts as collateral, reducing lender risk; this collateral is closely assessed by the mortgage underwriter. They also check the borrower’s credit history, income stability, property appraisal and valuation, and loan-to-value (LTV) ratio. Alongside, mortgage underwriters ensure that future mortgage payments can be managed by the borrower alongside other obligations.

Auto Loan Underwriting

Auto loan underwriting focuses on the borrower’s credit score, income, and the car’s value. Since the vehicle serves as collateral, lenders assess its market worth to ensure sufficient coverage for the loan amount.

Loan Underwriting Process: Manual vs. Automated

Here are the two primary processes that modern day underwriters use for loan underwriting:

1. Automated Underwriting

Automated underwriting is a technology-driven process that uses pre-designed computer programs (also known as Automated Underwriting Engines) to evaluate loan applications. The system automatically conducts the underwriting process based on information such as income, collateral value, and debt. Automated underwriting is faster than manual methods, which rely on human effort. As a result, it eliminates the need for manual review to a degree.

Automated underwriting processes can lead to improved workflows and increased customer satisfaction. Since it's algorithm-driven, there's less scope for mistakes, and it can determine eligibility for a loan in a matter of minutes. Overall, it leads to a smooth underwriting process, which is why many leading NBFCs have integrated this technology.

2. Manual Underwriting

Manual underwriting involves human intervention where a human underwriter assesses loan application documents such as financial documents, credit report, employment and income status, debt, etc.

While the manual underwriting process may take longer than the automated procedure, it takes various special cases into account, otherwise rejected by the latter. The human approach is useful for borrowers who have unique or complex financial situations, like:

• Little to no credit history

• Debt-to-income ratio is high

• Financial difficulties in the past

Difference Between Manual vs. Automated Underwriting

While automatic underwriting excels in various aspects when compared to the manual procedure, both have distinct pros and cons.

Understanding the difference between manual and automated underwriting can help borrowers navigate the loan process more effectively.

Parameter	Manual Underwriting	Automated Underwriting
Speed	Slower	Faster
Flexibility	High	Limited
Human Involvement	Yes	Minimal
Error/Bias Risk	Possible	Reduced
Best For	Complex cases	Standard applications

What Information Do Loan Underwriters Look At?

To correctly assess the lending risk involved, underwriters scrutiny a wide variety of information. This helps determine the borrower's creditworthiness and the lending risk involved.

Here’s a list of all the factors that underwriters need to examine before they approve of a loan:

• Financial History and Behaviour - Underwriters will examine the borrower’s entire financial history, including payment history on previous loans, any debts or financial obligations, and credit utilisation. Consistency in financial behaviour gets a green flag, while multiple missed payments and a bad debt-to-income ratio lowers the chances of loan approval.

• Income Sources and Employment Stability - Employment history receives a thorough scrutiny, including the duration of the current employment, any gaps in employment, and the stability of monthly income sources. This is done to ensure the borrower has sufficient funds to meet loan obligations.

• Current Financial Obligations - All existing debts, monthly payments, and financial commitments are evaluated by the underwriters since they could impact an individual’s ability to take on additional debt.

• Asset Portfolio - All assets, including savings accounts, investments, property ownership, and other valuable holdings are examined. The aim is to assess both the total value of all assets and how quickly these can be converted to cash if needed.

• Property and Collateral Valuation - This comes into the picture for secured loans that require collateral to be submitted. In some cases, the lenders may also need collateral to mitigate the risk of default when the borrower’s income or financial stability is shaky; collateral assessment will take place in these cases too.

• Documentation Verification - Some loans, like personal loans, involve minimal documentation, while others are more complicated. In all cases, it is essential for the lenders to verify the authenticity and accuracy of all documents. The process could include cross-referencing information across different documents and potentially contacting employers or banks for further confirmation.

Factors Affecting Loan Underwriting

Knowing the factors that are considered during the loan underwriting process for risk assessment can help gauge approval chances even before applying.

The following are some crucial considerations during the loan underwriting process:

1. Credit Score

Credit score and credit history are important factors taken into account as part of the underwriting process. They determine whether or not the applicant will be able to make timely repayments, influencing the eventual loan approval status. For this reason, a score above 750 is always advisable to maintain.

2. Income

Financial background and stability is a key consideration for lenders. In the underwriting process, both the gross (the amount earned before tax deductions) and net income (amount in hand after tax deductions) are taken into account.

This income verification is crucial. Lenders usually set up an income bracket below which they do not lend; anything earned below that bracket is seen as insufficient to cover the monthly payments.

3. Debt and Liabilities

The applicant's current level of debt and liabilities is a reliable signifier of their loan repayment ability. The Debt-to-Income Ratio (DTR) becomes an important factor here, which shows how much of an individual's income is spent on paying off debts.

A lower debt-to-income ratio indicates a better capacity for additional debt. On the other hand, most lenders avoid approving loans if it seems like the borrower is already in too much debt and unable to manage it.

4. Collateral Value

Collateral value assessment applies for secured loans, such as mortgage loans, car loans, and Loan Against Property, that require pledging an asset as collateral. However, if the pledged collateral is in poor condition, the loan application is prone to rejection. The collateral value should either be equal to or more than the amount that's being applied for. In the case of unsecured loans, this point won't come into consideration.

5. Purpose

The purpose for which a borrower is taking a loan may also reflect their creditworthiness. For example, a Personal Loan taken for debt consolidation may be perceived differently than one taken for personal expenses like vacations or weddings. This is why it is often considered in the loan underwriting process.

Rules of Loan Underwriting

Certain rules or standards related to the above-mentioned considerations are set by lending institutions to accurately determine creditworthiness. In general, the following rules provide a benchmark to assess borrower creditworthiness in the underwriting process:

• Credit Score - A credit score of 750 or above increases the chances of loan approval. As the borrower is perceived as low-risk, the lender may also offer a higher loan amount with more favourable terms.

• Income - Individuals with higher monthly incomes have more chances of getting loan approvals.

• Debt and Liabilities - Having a DTI ratio of under 30% is ideal.

• Collateral Value - Providing high-value collateral allows access to a higher loan amount at attractive interest rates as it is a low-risk loan on the lender's end.

Also Read :-  What is Minimum CIBIL Score Required to Get A Personal Loan?

What Are the Steps Involved in Loan Underwriting?

Though the process of loan underwriting largely depends on the type of loan, these steps are generally involved in the post-submission stage of a loan application for underwriting purposes:

Step 1: Reviewing income, the length of employment, and if there are any gaps in it.

Step 2: Debts and liabilities are checked by the underwriter, assessing the credit report and score. 

Step 3: Collateral evaluation of secured loans is conducted to ensure its value is sufficient to secure the loan amount.

Step 4: Satisfying additional conditions by providing additional documentation.

Step 5: Risk assessment once the above-mentioned information is gathered, evaluated and further assessed.

Step 6: Finalising the loan once it is approved.

How Long Does the Loan Underwriting Process Take?

Depending on the type of loan and the loan terms, the process can either be done in a few minutes, or over a few days or weeks. Whether it is a Personal Loan or any other type of loan, the objective of the lender is to determine the applicant’s creditworthiness based on specific factors before approving the loan request. Until the process is complete, the loan can't get approved.

In general, the more complex the loan application or the considerations, the longer the risk assessment and the underwriting process could take.

Documents to Gather for a Trouble-free Underwriting Process

Keeping essential and supporting documents ready to present can lead to an efficient and smooth underwriting process. Aside from the basics, underwriters often require additional documentation (such as updated bank statements) to confirm an applicant's financial details. In these cases, the faster the documentation is provided, the faster the process can resume.

Here’s the list of general documents to keep ready: 

• Recent bank statements

• Income documentation

• Credit report

• Tax returns

• Pay slips

• Asset value

• Photo ID

• Loan setup

• Employment history

• Address proof

• Debt-to-income ratio

• Mortgage statement

• Real estate tax verification

• Underwriting notes

Securities And Insurance Underwriting

These are the two other types of underwriting that exist aside from loan underwriting:

Insurance Underwriting: This involves receiving customer applications, assessing factors like insurance premiums and age, and deciding whether to offer them an insurance policy based on the various assessed criteria.

Securities Underwriting: Securities underwriting assesses risk and the appropriate price of particular securities, often in relation to an initial public offering (IPO).

To Conclude

Loan underwriting isn't just a creditworthiness review process; it helps the lending institution understand whether or not a potential borrower will be able to repay the loan on time. The fundamental risk associated with lending is non-recovery of loans, leading to significant financial losses. This is where underwriting helps identify and mitigate the risks before a loan is sanctioned.

With Poonawalla Fincorp, you can apply for a Personal Loan and get access to competitive interest rates under agreeable terms and conditions. With a swift underwriting process, you get fast loan approvals and other additional benefits like no use restrictions, flexible repayment tenure, no hidden-charges and more.

Also Read :-  The Ultimate Guide to Comparing Personal Loan Interest Rates

Frequently Asked Questions

What are the 4 Cs of loan underwriting?

Capacity, capital, collateral, and credit are the 4 Cs/components of loan underwriting. They stand for capacity to repay the loan on time, the capital that you can convert to cash, collateral to pledge as security, and credit score and history to assess creditworthiness.

Why do you need loan underwriting?

The process of lending, especially unsecured lending, comes with significant risk. Loan underwriting is needed for loan processors to assess these financial risks involved in providing a loan. Through this process, lenders do a thorough check of your credit history to verify if you will be able to repay the loan.

How do banks underwrite loans?

Banks and financial institutions usually have financial analysts or hire underwriters to assess the risk involved in approving the loan and the creditworthiness of the borrower. The underwriter applies the lender’s conditions and the underwriting rules to the borrower’s loan application. Additionally, technology helps in the automation of underwriting workflows and processes, detecting fraud, and reducing losses.

What are the factors affecting loan underwriting?

There are several factors that affect loan underwriting. A significant one is the applicant's credit history, especially their track record of on time payments. Other factors include income level and existing debt level.

How do lenders assess risk?

Lenders assess risk by examining an applicant's credit history and financial situation. The factors assessed can largely be captured in the "4 C's" framework: Capacity, capital, collateral, and credit. They reflect a borrower's repayment capacity, capital that can be converted to cash, collateral that can be pledged, and the credit score.

What documents do underwriters require?

Several financial statements and other supporting documents are required by lenders for underwriting. These include bank statements, income statements like salary slips, credit reports, tax returns, pay stubs, etc. They're required to assess the lender's cash flow and credit history as well as for employment verification.

What is the role of an underwriter in a loan?

An underwriter evaluates loan applications by assessing the borrower's creditworthiness, income, debts, and financial history to determine lending risk. They act as the decision-maker who approves or rejects loans based on the lender's criteria and risk assessment.

What is underwriting in easy words?

Underwriting is the process where lenders check your financial background before approving a loan. It's essentially asking "Can you afford this loan and will you pay it back?" by examining your income, credit score, and debts.

What is the difference between manual and automated underwriting?

The fundamental difference between manual and automated underwriting is human intervention. While manual underwriting is done by human underwriters, automated underwriting deploys Automated Underwriting Engines to assess loan applications.

How long does the underwriting process take?

Loan underwriting process can take anywhere between a few minutes to a few days. The actual process time depends of various factors including the complexity of the loan application, availability of requested customer information, documents and others.

How can technology improve the underwriting process?

Technology interventions in the loan underwriting process such as Automated Underwriting Engines can enhance customer experience by improving speed and accuracy of the overall underwriting process.

Can a loan be denied during underwriting process?

Yes. A loan application can be rejected during the underwriting process. Underwriting assesses the risk associated with the lending and if the risk is deemed to be too high, the application can be rejected by the lender.

How does the underwriting process differ for different types of loans?

Underwriters assesses lending risk in terms of various factors including the applicant's creditworthiness, income, purpose of the loan, lender's risk tolerance, etc. Each of these factors and their weightage in the underwriting process differs for different types of loans.

What role does credit score play in loan underwriting?

The credit score is the primary indicator of your overall creditworthiness in terms of repayment behaviour, credit utilisation, etc. As such, it plays a crucial role in the underwriting process wherein a higher credit score generally indicates lower lending risk and better chances of loan approval.

How does credit history impact loan underwriting?

Your credit history provides a deep insight into your past repayment behaviour. This is a crucial factor for evaluating lending risk and your ability to repay a loan. A good credit history with timely repayment behaviour reflects lesser risk of lending.

Can underwriters request for additional documentation during the process?

Yes. Underwriters may request additional documents during the loan underwriting process. This is common when the standard set of required documents may not be enough to assess the applicant's creditworthiness.