Loan underwriting: Everything you need to know

When a customer applies for a loan, they send all their financial documents and wait for you—the lender—to approve or reject their application.

Unless they're cash buyers, there’s one last hurdle to face before finalization: underwriting. The fate of their financing lies in the hands of a loan underwriter, who will determine whether your client is a risk.

Understanding the loan underwriting process helps you guide clients and increase their chances of securing the funds.

This guide explains the loan underwriting process and how to make it more efficient for your teams.

What is loan underwriting?

Loan underwriting is the process lenders use to determine the creditworthiness and risk level of a borrower before accepting or denying their application.

Before lending money to a borrower, you must:

• Assess the borrower's employment situation
• Determine their financial risk and payment habits 

This is where loan underwriting services come into play: A loan officer evaluates the borrower’s income, financial history, and credit report. With this information, the underwriter will either approve the loan, request more information, or refuse to take on the risk and reject the borrower’s application.

How the loan underwriting process works

Every lender has its own loan underwriting process with a strict set of guidelines based on capacity, credit, and collateral. Computer models also help underwriters analyze loans and the risk of lending to borrowers.

In the analog days, underwriters relied heavily on a borrower’s credit score to make lending decisions. This rating is still relevant today, but many lenders prefer cash flow and other alternative credit data points because it indicates the borrower’s repayment risk. FinRegLab, a nonprofit innovation center, found that deposit and credit card accounts provide a more comprehensive and detailed picture of the borrower’s cash flow. This provides data for loan underwriters to make informed lending decisions.

The mortgage underwriting process is long and tedious, depending on the methods and processes a lender uses. However, underwriters typically follow these five steps:

1. Receive the borrower's application and pre-approve the loan
2. Verify the borrower’s income and assets
3. Appraise the type of property the borrower wants to purchase
4. Perform a title search and get a title insurance policy
5. Make a decision

Let’s take a closer look at each step.

1. Receive the borrower's application and pre-approve the loan

Before the borrower looks for a property to purchase, they need pre-approval for the loan. As a lender, you’ll review the borrower’s financial information (income, debts, and credit history) to determine pre-approval for the loan.

Now, pre-approval differs from pre-qualification. The former indicates that the borrower is approved for a certain amount of money—and usually requires them to give the lender more details. The latter shows the borrower could get approval for the loan.

2. Verify the borrower’s income and assets

Once you pre-approve the borrower for the loan, the next step is income and asset verification. You’ll need additional documentation and information from the borrower, such as:

• Bank statements
• Tax returns
• Balance sheets
• Investment bank accounts
• Retirement savings
• Cash value of insurance policies
• Asset documentation (in the form of stock)
• Retirement bank account statements

If the borrower qualifies, you’ll issue a pre-approval letter with the approved amount based on the information they provided. The pre-approval letter shows property sellers the buyer’s serious and can back their offer with financing.

3. Appraise the property the borrower wants to purchase

The next step? For a mortgage, it would be to appraise the property to assess whether the amount the borrower offers is valid with the property’s: 

• Condition
• Size
• Complexity
• Other properties in the vicinity

Engage a licensed third-party appraiser to create a report based on a physical evaluation of the property compared to other similar, recently sold listings.

The appraisal process report shows the property’s actual value, so the underwriter can compare it to the sale price and calculate the loan-to-value (LTV) ratio.

4. Perform a title search and get a title insurance policy

Another step in the mortgage loan process is to determine if the house has any issues (such as legal claims). To do this, you can perform a title search with a title company to ensure the property is transferable.

Title searches look for information, including:

• Property details and history
• Existing mortgages
• Liens
• Zoning ordinances
• Claims
• Unpaid taxes
• Restrictive covenants
• Easement rights
• Pending legal action

Then, a title insurer gives the mortgage lender at least one insurance policy that guarantees the accuracy of its research and findings to protect the lender and property seller.

5. Make a loan decision

Depending on the underwriter’s review of the loan application, they can either:

• Approve the loan: The loan underwriter advises the lender to approve the loan so the borrower can close on the property.
• Approve with conditions: Loan approvals may come with conditions such as providing proof of insurance, pay stubs, and other personal documentation before allowing the borrower to close.
• Suspend the application: Sometimes the borrower may provide insufficient documentation or have missing files, making it hard to evaluate their application. In such cases, underwriters could suspend the mortgage application and advise the borrower to reactivate it once they have sufficient information.
• Deny the loan: If the borrower has additional debt or their credit score rating is questionable, the underwriter may deny their loan application. Borrowers can either re-apply later, apply for smaller loan amounts, or get a larger deposit on the house to compensate.

The loan underwriting process can last from a few days to several weeks, depending on:

• Whether the underwriter is satisfied with the information they have
• The lender’s practices
• How busy the lender’s underwriting team is
• How fast the borrower compiles their paperwork and responds to the lender’s requests for additional documents

Once the borrower meets all the pending conditions, the lender will approve their application and fund the loan.

Challenges lenders face during the loan underwriting process

Innovations in banking technology have increased consumer demand for faster service. These changes came with multiple challenges for lenders in loan underwriting and digital lending, including:

• Meeting customer expectations: Today’s customers expect lenders to operate with speed and accuracy, and offer 24/7 support for a smooth lending process.
• Unifying customer data: Loan underwriting is a paper-heavy process requiring lots of documentation and multiple reviews. Lenders face challenges when consolidating customer data to complete reviews in an organized yet timely manner while providing excellent, transparent customer service.
• Slow decision-making processes: Compared to digital lenders, big banks and other financial institutions are slow at approving or declining loans. This was further disrupted during the pandemic, which impacted the speed of the loan origination process.
• Long, clunky lending process: Borrowers desire a streamlined loan approval process without going to the banking hall. But sometimes they wait months for approval due to a long process that involves several people.
• Complex industry regulations: From the onset of the pandemic, lenders have faced multiple compliance and regulatory curveballs, which continue to challenge risk management.
• Cost-effectiveness: Lenders slower at implementing digital lending systems face cost challenges in loan origination and processing, closing costs, and delivery.

How to ensure a smooth loan underwriting process

Loan underwriting has multiple tedious parts, but you can save your team hours per week without increasing your risk exposure using digital tools like Inscribe.

This AI-powered fraud detection and document automation platform:

• Streamlines your underwriting workflows
• Eliminates time-consuming document reviews
• Detects fraud that’s invisible ot the human eye

With Inscribe, you and your team can approve more customers faster and with confidence.

VIVA Finance—a fintech company in the consumer lending industry—wanted to expand into new markets. The team experienced a fraud scare as scammers became more sophisticated in creating deceptive documents.

In addition, the company’s growth increased its risk exposure and its manual review teams were struggling to quickly learn the intricacies and nuances of new documents.

By using Inscribe’s robust technology, VIVA Finance transformed its document review process and improved fraud detection with artificial intelligence (AI). The results:

• Over 40,000 documents uploaded and accurately analyzed for fraud within seconds
• Reduced application response times from two to under one business day
• Ability to scan and understand fraud signals in suspicious documents to make lending decisions confidently
• Reduced chances of human errors and better efficiency

Ready to streamline your loan underwriting process to make it faster, simpler, and more efficient? Talk to one of our experts to get started.