When you apply for any loan, there are a lot of steps involved before it gets approved. This is because for lending companies, giving a loan involves a certain amount of risk. To evaluate how much amount is to be disbursed to you, lenders gauge the risk of lending you the loan based on various factors. This process is known as loan underwriting. In this article, you will understand the loan underwriting meaning and the factors involved in it.
Loan underwriting is a step in the loan approval process where the lender evaluates your creditworthiness. The lender will verify your income, debt, assets, etc to assess whether you meet their eligibility criteria. This underwriting process aims to minimize the lender's risk by ensuring that loans are granted to individuals or businesses who are highly likely to repay. 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.
Speaking of the Personal Loan underwriting process in particular, the definition is same as of other kinds of loans. However, the processes involved in it can differ slightly.
Automated underwriting is a technology-driven process that uses pre-designed computer programs (also known as Automated Underwriting Engines) to evaluate your loan applications. The system automatically generates underwriting based on information such as income, collateral value, and debt entered the system, which reduces the need for manual review.
As an algorithm-driven process, it is free of human error. Also, unlike a manual underwriting process that can take days or even weeks, automated underwriting can even determine your eligibility for a loan in a few minutes. Many leading NBFCs have integrated this technology into their Personal Loan underwriting process too.
While it is slower than automated underwriting, manual underwriting is useful for borrowers who have unique or complex financial situations and are likely to be rejected by the automated process. The human approach that comes with manual underwriting can help in the following conditions:
Underwriting rules or standards are specific guidelines set forth by lending institutions for determining your creditworthiness. Here are some of the underwriting criteria for loans that are considered:
Your credit score is one of the most crucial factors influencing your loan approval since it determines if you are reliable in paying on credit. A credit score represents how prudent you have been in repaying your past loans. A credit score of 750 or above gives you a higher chance of loan approval. As you are perceived as a low-risk borrower, the lender may also give you a higher loan amount with more favourable terms.
Income refers to both gross (the amount a person earns after tax deductions) and net income. Most lenders have an income bracket below which they usually do not lend since they believe that a borrower’s income cannot cover the monthly payments for a loan. They will also check your bank statements to ensure there is no income gap. Moreover, if you have multiple sources of income, make sure to mention that as well. Individuals with higher incomes have more chances of getting loan approvals.
Your current level of debt and liabilities significantly impacts your loan repayment ability. So, the lenders investigate the amount of debt you have, to check if you can afford to pay back the loan. Your Debt-to-Income Ratio (DTR) becomes an important factor here, which shows how much of your income is spent on paying off your debt. Having a DTI ratio of under 30% is ideal.
Secured loans, such as home loans and car loans, requires you to pledge an asset as collateral. Keep in mind that if your collateral is in poor condition, your loan application may be rejected. So, your collateral value should either be equal to or more than the amount you are applying for. Providing collateral also means you get a higher loan amount at lower interest rates as it is a low-risk loan for the lender.
The process of loan underwriting depends on the type of loan. Here are the general steps involved after you submit a loan application:
Underwriting is the process of assessing creditworthiness and understanding if the borrower will be able to repay the loan. Depending on the type of loan you are applying for, the process can take either a few minutes or a few days. To ensure a smooth underwriting process, get all your documents in order, avoid applying for loans from multiple lenders, and boost your creditworthiness.
The 4 Cs or components of loan underwriting are capacity, capital, collateral, and credit. Capacity to repay the loan, capital that you can convert to cash, collateral to pledge as security, and credit score and history to assess your creditworthiness.
Loan underwriting is needed for lenders to assess the risk involved in providing a loan. Through this process, lenders do a thorough check of your financial condition to verify if you will be able to repay the loan.
Banks or 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.
We take utmost care to provide information based on internal data and reliable sources. However, this article and associated web pages provide generic information for reference purposes only. Readers must make an informed decision by reviewing the products offered and the terms and conditions. Personal Loan disbursal is at the sole discretion of Poonawalla Fincorp.
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