Financial institutions take on risks while lending. The process of conducting due diligence by the lenders before accepting risks of approving a loan or a mortgage is underwriting.
The origins of the term ‘underwriting’ stem from the practice of risk-takers writing their names under the extent of risk they were ready to take, for a specified fee. Underwriting continues to serve an important role in the financial world of investments and mortgages, even though the mechanism has changed with time.
Mortgage Underwriting Process
The underwriting process begins with a prospective borrower applying to their lender for a loan or a mortgage. A mortgage underwriter checks the borrower’s application for any discrepancies, inaccuracies, or misrepresentation of facts.
The job of a mortgage underwriter is to examine and analyze loan applications to identify potential risks. While scrutinizing the loan applications, an underwriter may crosscheck the borrower’s credit reports and employee records.
An underwriter may need to check tax filings, assets and liabilities statements, or any other records furnished by the applicant to determine if they conform to the loan approval protocol of the lender.
Typically, underwriters discharge their duties with the help of various equations, database research, software programs, and AI applications. On the completion of the due diligence process they will send their final report of approval, or denial, of the application to the mortgage officer at the financial institution.
While some applications earn prompt approval, many others may have to go through a prolonged process facing denials or delays for weeks, or even months. These checks and balances help to set interest rates, premiums, and investment risk thresholds for various financial products such as mortgages, insurance policies, and securities.
The underwriter reserves the right to deny an application if the risk seems to be too high. Typically, bigger mortgage companies have a greater risk appetite and a diversified portfolio of loan products than their smaller counterparts.
Key Challenges for Underwriters
While some mortgage applications secure an underwriter’s approval without any alterations, others may consist of issues ranging from minor typos to major omissions. These issues may slow down or impede the underwriting process. Challenges facing mortgage underwriters fall into three major categories, namely, capacity, credit, and collateral. We discuss some of these issues below:
- Applications Lacking Complete Information
Applicants must fill in and provide complete information for the underwriter to start the due process. Loan officers at the lending institutions must ensure that there are no omissions in the loan application form filled by the applicants before they send them to the mortgage underwriters.
Any missing data in the application form such as a signature, a figure, or a document, can prevent the underwriting process from moving along. An application with complete information is essential to begin a loan approval process.
- Income Discrepancies
Some applicants might fill in inflated figures while reporting information about their income as a deceptive effort to ensure loan approval. Underwriters need to scrutinize and compare figures in the applicant’s bank statements, W-2s, tax returns, and related records to establish the applicant’s real income.
This helps mitigate the risks for the lenders. Some mortgage undertakers also use online tools and websites like Salary.com to verify income information filled in by the loan applicants.
- Tax Document Inconsistencies
Some mortgage borrowers mistakenly fill in their gross incomes in the loan application forms, not realizing that lenders take taxable income or Adjusted Gross Income (AGI) into account to assess risk while underwriting mortgages.
Just as with income-related information, documents related to tax information must match up with other financial data to facilitate loan approval by a mortgage underwriter. Underwriters need to be wary of distorted or falsified information.
- Employment Instability
Mortgage underwriters look for consistency and stability in the employment and income records of borrowers. One of the main parameters to judge an applicant’s repayment capacity is their history of making long-term financial commitments.
Disruptions in employment patterns such as an applicant turning self-employed in the recent past, lead to underwriters having to make judgment calls based on insufficient information.
A mortgage applicant’s inability to show consistency in employment or income can raise red flags for underwriters. In these types of situations, explanation letters providing reasons for inconsistencies can help underwriters make sensible decisions.
- Credit History
Loan applicants need to meet the minimum requirements for credit score and history. It is not possible for the underwriters to ignore poor credit history of an applicant even if they meet all other requirements of the lending institution.
Underwriters dig deep to confirm an applicant’s credit history with creditors and credit bureaus. A history of far too many lines of credit and late repayments can become major challenges for mortgage underwriters.
- Funding Problems
The inability of a borrower to meet the minimum upfront payment requirement can create issues for underwriters. Mortgage underwriters need to see transparent information regarding the origin and availability of funds.
Prospective borrowers must demonstrate evidence of funds for the upfront payment, cash reserves, and closing costs. The failure of borrowers to provide the proper funding information leads to the rejection of loans by the underwriters.
- Property Valuation Issues
Sometimes, appraisal of the property, and not the borrower’s application, causes problems for the mortgage underwriters. No agreement between the seller and the buyer on price, or a low appraisal valuation, leaves the underwriters little chance of approving the loan application.
Mortgage applicants can take certain steps to mitigate the issues they face with mortgage underwriters. Letters explaining anomalies in credit history, employment records, or tax documents, can go a long way in helping underwriters understand an applicant’s situation. It enables the underwriters to make sagacious decisions, and reduce the chances of denial or suspension of an application.
Mortgage industry regulations keep evolving. Mortgage underwriters play a critical role in the entire home mortgage process and will continue to do so. They have the authority to approve, reject, or delay a mortgage application.
One misjudgment on their part could lead to losses worth thousands of dollars for the lenders. Apart from applying the traditionally prescribed parameters of underwriting, the mortgage industry needs to move towards AI and machine-learning solutions to overcome these key challenges.
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