Loan Underwriting in Simple Terms

If you’ve ever applied for a loan, you’ve probably heard the phrase, “Your application is currently with underwriting.”

Have you ever stopped to think about what that means? You know, really considered who or what it is that determines if you’ll be able to buy your dream home or finance some other big-ticket purchase?

It’s time to take a bit of the “mystery” out of lending by shedding light on a behind-the-scenes phenomenon known as loan underwriting.

What Does Loan Underwriting Mean?

The term “underwriting” can be traced back to London in the 1600s, when people who were willing to insure shipping vessels and voyages literally wrote their names on a manifest under the amount of risk they were willing to accept.

Today, loan underwriting is the process a financial institution like a credit union or bank goes through to determine the risk associated with lending you money. Typically, this involves:  

• Verifying your income
• Reviewing your credit history
• Evaluating your current assets and outstanding debt
• Appraising collateral (for secured loans)

Using this information, underwriters will then decide whether to approve or deny your loan.

If they’re not quite sure whether to say yay or nay to your application, they may ask for additional documentation like pay stubs, W-2s, tax returns, or an appraisal of your collateral (if not already on file).

Underwriting has evolved quite a bit in the centuries since early English risk-takers gathered in coffee houses to discuss terms and conditions of maritime insurance.

Depending on the type of loan you’re seeking, the process can now be done on paper or online and take anywhere from a few minutes to several weeks to complete.

Unsecured Loans

Lenders typically use underwriting software to review applications for unsecured loans. The computer program analyzes your credit score and income information, and typically approves or declines your loan request within seconds or minutes.

Loans that fall into this category include:

• Personal Loans
• Unsecured Credit Cards
• Student Loans
• Personal Lines of Credit

Secured Loans

Since secured loans require collateral (a personal asset transferred to your lender in the event you default) and generally involve larger amounts of money than unsecured loans, they usually need to be reviewed by an actual underwriter.

That means the underwriting timeline — aside from auto loans, which can usually be processed in less than an hour — could stretch to two or three weeks. This applies to such loans as:  

• Mortgages
• Home Equity Loans
• Home Equity Lines of Credit (HELOCs)
• Secured Personal Loans

Can an Underwriter Deny Your Loan?

Yes, an underwriter can and will deny your loan application if they believe there’s a good chance you won’t be able to repay the money (plus interest). They might also deny you if issues arise with the collateral you’re using for a secured loan.

What Are Red Flags for Loan Underwriters?

When it comes to approving or denying your loan request, there are a number of red flags that could give an underwriter reason for pause.

For unsecured loans, common warning signs include:

Low Credit Score: Your credit score is a three-digit number that ranges between 300-850, and the higher it is, the better. You’ll need a score of at least 580 to qualify for a personal loan or other unsecured financial products.

Poor Credit History: Your credit report provides a detailed record of your borrowing and repayment history. If you have numerous negative marks for late or missing payments, that could hurt your chances of obtaining a loan.

Unverifiable Income: You’ll need a steady source of income and documents such as pay stubs, bank statements, and W-2s to prove you earn enough to repay the money you borrow. If you haven’t been consistently employed or if you don’t submit all your paperwork, it could stop or slow down the loan approval process.

High Debt-to-Income (DTI) Ratio: Your DTI ratio, which is calculated by dividing your total monthly debts by your gross monthly income, helps lenders determine if you’ll have enough cash to make your loan payments. Keeping your DTI ratio below 30% can increase the likelihood that your loan will be approved.

How Long Does the Loan Underwriting Process Take?

Underwriters will certainly consider these factors when reviewing your application for a mortgage and other types of secured loans. However, they’ll also be looking for such additional red flags as:

Undocumented Cash Deposits: Although that $10,000 gift from your parents you deposited last month looks good for your account balance, it will raise an underwriter’s eyebrow if you can’t document where or how you got the money. Lenders want to ensure you didn’t take out another loan (or do something questionable) to get the extra cash, so make sure you have a way to prove in writing the source of any large deposits.

Recent Large Purchases or Credit Checks: As a rule, you should avoid temptations like buying a car or opening a new credit card in the weeks leading up to and during the time your secured loan application is being reviewed. Multiple hard credit inquiries will temporarily lower you credit score, and large purchases of any kind will likely skew your DTI ratio — either of which could cause issues with your loan being approved.

Appraisal Problems: Before approving you for any type of secured loan, the lender has to determine the value of the asset you’re offering as collateral. With mortgages, the underwriter will order an appraisal to confirm the offer you made – and amount of money you’re trying to borrow – reflects the home’s fair market value.

The appraiser will inspect the condition of the home and its features, and then compare it with other properties that have recently sold in the area. If the appraiser values the home far above or below the asking price and the offer you made, the underwriter may pump the brakes on your loan.

Title Issues: Whether you’re trying to finance a house, car, boat, or some other type of property that requires transfer of ownership, your lender will do a title search to ensure no one other than the seller has a legal claim to the asset.

If the search finds, for instance, that the seller defaulted on their loan and their lender placed a lien on the property, you can’t take over the title. Obviously, this would be a reason the underwriter would deny your loan application or postpone approval until the issue is resolved.

Tips for a Better Loan Underwriting Experience

While technology has streamlined the approach for reviewing many loans, underwriting — particularly for complex lending arrangements like mortgages — seldom plays out like a fairytale for the borrower or lender.

There are, however, ways to make the overall process more enjoyable for you and the person who’ll ultimately decide if you’re able to buy that cozy bungalow you made an offer on or that sailboat you’ve been dreaming about. Here are four tips for a better underwriting experience:

1. Get Organized

Regardless of the type of loan, the underwriter will need to verify your income. You can help the process run more smoothly by pulling together the following documents and having them readily available when you meet with your lender (some items may vary by lender):

• Employment information and W-2s from the past two years
• Pay stubs from two to three months before the date you apply
• Income tax returns from the previous two to three years
• Statements from checking, savings, and money market accounts
• Information on CDs, retirement plans, and other investments

2. Boost Your Credit

The higher your credit score, the better your chances of being approved for a loan and getting the best interest rate possible. If you need to improve your credit score, try to pay down some of your outstanding balances — especially high-interest credit card debt — quickly and commit to reducing your credit utilization to less than 30%.  

3. Respond Promptly

Regardless of how organized and thorough you are, the underwriter may ask for additional documents. Expect those calls or texts from your lender and try to gather everything needed as fast as you can — the underwriter won’t be able to move forward with your application without them.

4. Be Transparent

Your loan application isn’t the place to exaggerate your income and assets or be less than forthcoming about any credit issues you may have experienced in the past. Instead, be upfront and prepared to explain any negative marks that might appear on your credit report.

The Takeaway

Underwriting is a systematic approach to evaluating loan applications that’s ultimately designed to protect lenders and borrowers alike.

So, by taking time to understand the role of underwriters, avoiding common underwriting red flags, and addressing any issues that may arise when your application is under review, you can remove the uncertainty of the experience and boost your chances of being approved.