Underwriting: A Complete Overview

Not all lenders are created equal, but there are certain areas of the lending process they have in common.

Underwriting is one of them. This process helps lenders understand their customers and their risk status to safeguard against unexpected loss.

In this guide, we’ll help you understand what underwriting is, the different types of underwriting lenders perform (consumer, business, loan, etc.), the difference between manual and automated underwriting, the steps in the underwriting process, and what lenders look for.

What is underwriting?

Underwriting is a lender’s process of evaluating and managing risk. Through underwriting, banks and other financial services providers carefully review a borrower’s credit history and financial background to determine their eligibility for a loan.

Once a borrower submits a loan application and it’s accepted, the underwriting process kicks in. The credit underwriter assesses the borrower’s finances and past credit decisions to give them an overview of their degree of risk.

For example, when a borrower applies for a home loan, the lender will rely on underwriting to evaluate the application and determine whether to approve or reject the mortgage. If you operate an investment bank, underwriting can help you raise money for a client, like in an initial public offering (IPO).

Types of underwriting lenders perform

Some of the main types of underwriting lenders perform include:

• Mortgage underwriting: With mortgage or home loans, the underwriter dives into the applicant’s finances, looking at their credit score, credit and income history, employment situation, and other details to assess the financial risks and rewards of approving the application. Refinancing a mortgage loan also requires underwriting.
• Auto Loan Underwriting: For auto loans, lenders evaluate the borrower's credit history, income, employment status, and the value of the vehicle being financed.
• Personal Loan Underwriting: Personal loans are typically unsecured, so lenders heavily rely on the borrower's credit history, income, and debt-to-income ratio to assess risk.
• Business Loan Underwriting: Business lenders assess the creditworthiness of businesses seeking financing. This can include a review of the company's financial statements, business plan, credit history, and the owner's personal credit and financial stability.
• Credit Card Underwriting: Credit card issuers use a combination of credit history, income, and other factors to determine credit limits and interest rates for cardholders.
• Commercial Real Estate Underwriting: This type of underwriting evaluates the creditworthiness of businesses or investors seeking loans for commercial real estate properties. Lenders assess the property's income potential, the borrower's financial stability, and the economic viability of the project.
• Insurance Underwriting: In the insurance industry, underwriters evaluate risks associated with insuring individuals, businesses, or assets. They assess factors like health, age, occupation, and property conditions to determine insurance premiums and coverage.
• Securities underwriting: Prior to taking a company public via direct listing or IPO, banks and special purpose acquisition companies initiate securities underwriting. The goal is to determine the asking price for securities or the actual value/worth of the company shares. Here, the risk assessment is done for the investor — not on behalf of the company — so lenders have little control.

You can also think about underwriting from the perspective of who is being evaluated: a business or a consumer.

Consumer Underwriting

Consumer underwriting is the process by which lenders, financial institutions, and credit providers assess the creditworthiness and risk associated with individual consumers who are applying for credit or loans. 

The primary goal of consumer underwriting is to make informed decisions about whether to extend credit to a particular consumer and, if so, on what terms (interest rates, credit limits, repayment schedules, etc.). Here are some key aspects of consumer underwriting:

1. Income Verification: Lenders typically require consumers to provide proof of income as part of the underwriting process. This helps determine if the applicant has a stable source of income to repay the loan or credit. Documentation may include pay stubs, tax returns, or bank statements.
2. Debt-to-Income Ratio: Lenders calculate the debt-to-income (DTI) ratio to assess a consumer's ability to manage additional debt. This ratio compares the consumer's monthly debt payments to their monthly income. A lower DTI ratio indicates a lower level of debt relative to income, which is generally seen as more favorable.
3. ‍Employment and Stability: Lenders often consider an applicant's employment history and stability. A stable employment record can be a positive factor in the underwriting process, as it suggests a consistent source of income.
4. ‍Other Financial Information: Lenders may consider various other factors, such as the consumer's savings, assets, and expenses, to gain a more comprehensive view of the applicant's financial situation.‍
5. Regulatory Compliance: Lenders are required to comply with various consumer protection laws, such as the Truth in Lending Act and the Equal Credit Opportunity Act, which prohibit discrimination and ensure transparency in lending practices.‍
6. Risk Assessment: Based on the information collected and analyzed during the underwriting process, lenders assign a risk level to the applicant. This risk level helps determine the terms and conditions of the credit being offered, such as interest rates, credit limits, and repayment schedules.

Consumer underwriting aims to strike a balance between providing access to credit for consumers who can manage it responsibly while managing the lender's risk exposure. The specific criteria and scoring models used in the underwriting process can vary among lenders and financial institutions, but they all aim to make data-driven decisions that align with their risk tolerance and lending policies.

Business Underwriting

Business underwriting is the process by which lenders and financial institutions assess the creditworthiness and risk associated with businesses applying for loans or credit. 

This process is critical for evaluating the financial health, stability, and repayment capacity of businesses seeking funding for various purposes, such as expansion, working capital, equipment purchase, or real estate investment. Here are some key aspects of business underwriting:

1. ‍Financial Statements: Lenders typically require businesses to provide financial statements, including balance sheets, income statements, and cash flow statements. These documents offer insights into the company's financial performance, profitability, and liquidity. Lenders analyze key financial ratios to assess the business's ability to meet debt obligations.
2. ‍Business Plan: In some cases, especially for startup businesses or those seeking substantial financing, lenders may request a detailed business plan. This plan outlines the company's objectives, strategies, market analysis, and financial projections, providing a comprehensive view of the business's viability.
3. ‍Personal Guarantees: In many cases, especially for smaller businesses or startups, lenders may require personal guarantees from the business owners or principals. This means that the owners are personally responsible for repaying the debt if the business cannot.‍
4. Business Stability: The length of time a business has been operating and its track record of success can play a significant role in underwriting. Lenders typically favor businesses with a history of stable operations.‍
5. Debt Service Coverage Ratio (DSCR): Lenders calculate the DSCR, which measures the business's ability to cover its debt payments. It's the ratio of the business's net operating income to its debt obligations. A higher DSCR is typically viewed as more favorable.‍
6. Regulatory Compliance: Lenders must adhere to various laws and regulations, including the Equal Credit Opportunity Act and the Community Reinvestment Act, to ensure fair and responsible lending practices.

Business underwriting aims to determine the risk associated with lending to a business and to set appropriate terms and conditions. The specific underwriting criteria and risk assessment methods can vary among lenders, and they use this information to make informed decisions about whether to extend credit to a business and on what terms.

There are two ways lenders underwrite their customers’ loans: manually or automatically. Let’s review these two methods next.

Manual vs. automated underwriting: What’s the difference?

Credit underwriters used to employ manual underwriting methods to assess borrowers’ creditworthiness. This involved reviewing an applicant’s financial situation and other pertinent details to decide whether to approve or deny the loan.

As more consumers borrow loans, regulations also changed, which had an immediate and large impact on the underwriting process. Lenders and credit bureaus centralized their processes. Computers were also readily available, offering new insights for lenders to make more complex and profitable decisions at scale.

With more data and computing power, lenders have a complete picture of borrowers’ creditworthiness and can automate the underwriting decision-making process.

The result? Improved workflows and increased customer satisfaction.

A Global Insights Report by Experian shows most businesses say investing in digital decisioning software is the best way to improve engagement and customer acquisition. In addition, business owners plan to invest in artificial intelligence (AI) and increase their staff’s digital capabilities.

From the report, 60% of businesses plan to increase their budget for credit risk analytics, which AI and machine learning (ML) offer. This helps lenders by:

• Streamlining the underwriting process
• Giving them a clearer view of a borrower’s creditworthiness
• Improving credit risk management and decisioning
• Increase operational efficiency
• Grow revenue
• Provide a positive customer experience

Automated underwriting is faster than manual methods, which rely on human effort to sift through and evaluate volumes of individual loan applications and financial statements. However, automated systems are also limited in unique borrower circumstances, such as varied incomes, in which case manual underwriting makes it easier for the lender to qualify a borrower.

An underwriting survey by Accenture, in partnership with The Institutes, found that underwriters use technology for better decision-making. 46% of those surveyed say it has positively impacted automation or elimination of non-core tasks. They also feel technology may cause more harm despite it boosting their speed to quote, access to knowledge, and ability to handle larger amounts of business. 

Lenders looking to gain a competitive edge use a combination of manual and automated underwriting methods (like the Fannie Mae Desktop Underwriter) to gauge a borrower’s loan eligibility and financial risk.

Whenever an automated system flags a borrower’s application, a human loan officer will review and analyze it again to determine the best approach.

What are the steps in the underwriting process?

Bank underwriting will differ from company to company and depend on the type of loan.

For instance, underwriting a personal loan would differ from that of a mortgage, which includes extra steps like appraisal and title search, and insurance to determine how much to lend the borrower.

However, lenders follow similar strict underwriting guidelines, which may be accompanied by computer models for loan and risk analysis.

Typically, the underwriting process follows these steps:

• Screening: Once a borrower submits their loan application, a loan officer screens the documents for creditworthiness before turning it over to the underwriter. This involves credit checks and a review of the applicant’s business finances.
• Underwriting: The loan officer sends the application to an underwriter who double-checks it to get all the information they need for underwriting analysis. This is a deeper dive than the initial assessment by the loan officer because the underwriter determines whether to approve or reject the application. They’ll also appraise the borrower’s business to know if they can afford to repay the loan and set a risk value for the company.
• Loan approval, suspension, or denial: Based on the underwriter’s report and recommendations, the lender will approve, suspend, or deny the borrower’s loan application. If approved, the lender takes on the risk and stipulates the loan and repayment terms. If suspended or rejected, the underwriter may ask for more information to make a more informed decision. And if rejected, the lender won’t take on the risk and denies the application altogether.

What do underwriters look for in a loan application?

When reviewing loan applications, most lenders focus on three primary concerns:

• Credit: Underwriters review the borrower’s credit report to see how they’ve handled debt repayment in the past. To determine the best type of loan and interest rate for the borrower, they’ll check to see how much credit the applicant has taken on, the loan terms, and any red flags in their credit history.
• Capacity: The underwriter also reviews the applicant’s loan repayment ability, comparing their income against recurring debts to compute a debt-to-income ratio. They’ll also consider IRA accounts, 401(k), tax returns, W-2 forms, pay stubs, and bank statements to ensure there’s enough money to make a down payment and cover future mortgage payments.
• Collateral: A review of the applicant’s collateral will help hedge the lender’s bet in case the borrower defaults on the loan.

Underwriters fact-check all these details to ensure the borrower’s financial picture and documentation are accurate, while verifying they meet all requirements of the loan program. Once underwriters review all the paperwork and information they need, they’ll give the lender their risk analysis and recommendations.

How can lenders ensure a smooth underwriting process?

From Accenture’s survey, the challenges impacting underwriters’ ability to achieve business goals are:

• Inefficient processes
• Outdated systems
• Lack of information or analytics at the point of need
• Poor underwriting information access or organization
• Insufficient focus on talent development or training

Thanks to AI and ML technology, lenders can not only automate their lending workflows and processes, but also improve document collection, detect fraud, and reduce losses.

In fact, 32% of Accenture’s survey respondents described AI, natural language processing (NLP), and robotics as superior tools for the underwriting process. And in the next three years, 71% of businesses will invest in predictive analytics, 67% in new underwriting platforms, and 67% in business intelligence and reporting tools.

These numbers underscore the need for underwriting software in the lending process.

Future-proof your underwriting processes

There’s no such thing as a perfect underwriting process. But you can upgrade your tech stack and build processes that can handle volumes of applications while improving your underwriting team’s productivity and decisioning times.

Inscribe — an AI-powered fraud detection and automation tool — streamlines the most tedious, time-consuming parts of your underwriting workflow, saving you hundreds of hours per week without increasing your risk exposure.

With Inscribe, you can automate your underwriting process, detect fraud, and understand your customers’ creditworthiness to approve more loans, faster.

Sound like a solution for your workflow? Talk to an Inscribe expert today.