Underwriting in real estate is a process that evaluates the risk of a transaction. Banks need to do everything they can to minimize their risk, and they do this by Analyzing the buyer’s application to determine the risk of making the loan. This includes two parts, the underwriter:
- Reviews the potential borrower’s credit history
- Judges the property’s value
Since the house is used as collateral for the loan, underwriters use a debt service coverage ratio (DSCR) if the property can redeem its own value. If the property can cover the expense of the loan, then it is a secure proposition, and the bank will likely accept the deal.1
Why is Underwriting in Real Estate Important?
Underwriting is important because it helps lenders avoid potentially risky deals. Banks cannot stay in business if too many loans default, so they use this process to minimize as much as possible the number of bad deals. This process:
- Determines the creditworthiness of the borrower
- Ensures the applicants represent themselves truthfully
- Determines if the sale price meets the appraised value
- Ensures that no one else is on the title
It is important to protect the market as much as possible from bad deals. Poor lending decisions led to the housing crisis during the last decade.2
The Function of an Underwriter
The main function of an underwriter is to protect the lender from entering a bad deal. If you’re thinking all of this is to protect the bank, then you’re right. So, why is it important to you?
- If the bank makes too many bad loans, they go out of business.
- Then there is no capital market for a mortgage.
- Even if bad loans don’t sink the bank, then interest rates will go very high to cover credit risk.
It is also in your best interest for the bank to make good loans. These professionals help banks from entering bad transactions, which helps keep interest rates lower, and stabilizes the housing market,
The Underwriter in a Transaction
The bank hires the underwriter to evaluate the property and the land. They are professionals who fact-check the application and the property to minimize risk. They may be:
- An employee of the bank
- a third-party professional hired by the bank.
In either case, the lender wants them to work independently, so they return unbiases results.
Loan Officers and Underwriters
Loan officers do work together with underwriters, but they have very different jobs. A loan officer:
- Is the salesperson for the lender
- Helps borrowers understand the mortgage process and find the right type of loan
- Fills out paperwork with the potential client for the loan and walks them through from beginning to end
Underwriters, on the other hand, have a specific mandate, to assess credit risk for the deal. The loan officer communicates with the underwriter about what information the borrower needs to provide and alternatives if there is a problem. A diligent mortgage representative does everything they can to make the deal work. That includes acting as a go-between to provide documents, information, and options.
What Do Banks Look For When Underwriting in Real Estate?
Underwriters look for potential credit risks with the buyer and possible risks associated with the house. They generally look for three things:
- Credit – Your credit history or payment records
- Capacity – Your income, assets, and liabilities
- Collateral – Your down payment and home value
The bank wants to know more than if your credit score is good. They also want to know your capacity to borrow. Remember that this is a big loan, and they want to make sure you aren’t getting in over your head with too much debt.
Why do Underwriters Deny Loans?
Underwriters deny loans because they believe the credit risk is too high. Within that context, there are many reasons. Some of the most common include:
- History of late payments
- Job-status changed
- Omitted information on the application
- Recently opened credit accounts
- Don’t have enough cash to close
- Home appraisal too low
It is discouraging when the bank denies your loan, but it doesn’t mean you should give up on buying a house. As you can see there are a lot of reasons why the lender may deny a loan. You can fix most of these, though. Work with your mortgage broker to clear the times that prevented you from getting the loan, and then try again.3
Can Underwriters Make Exceptions?
Underwriters generally do not make exceptions, but it depends on what you mean by exceptions. There are three answers that they will generally give you:
- Approved or conditional approval
Most of the time you must meet some conditions because you missed a signature somewhere or need to clarify a late payment or large deposit. Less often they suspend your loan application. This is more serious and is usually because of employment or income issues. If the bank denies your loan it could be something very serious, but it may be that you fill out the application wrong, you need a larger down payment, or your credit report contains an error.4
Final Thoughts on Underwriting in Real Estate
Underwriting in real estate is a long, complicated process. It can be tedious and frustrating. This underscores the importance of finding a good mortgage broker. Like a good realtor will guide you through the buying process, a diligent professional loan officer will guide you, give you advice, and offer you options.