Underwriting in Real Estate: Definition & Requirements

Instructor: Ian Lord

Ian has an MBA and is a real estate investor, former health professions educator, and Air Force veteran.

Underwriters examine and evaluate the risk of offering a mortgage applicant a loan before the lender approves funding. They base their decision on a comprehensive review of the borrower's finances and specific details of the mortgaged property.

Underwriting Definition

Kevin and Mary have had their offer accepted and are set to close on their new home on the first of next month! After some celebrating that they found their new home, they got an email from their agent. Uh oh. The agent says they have to go through underwriting to get their loan approved. What? They were already pre-approved! They call their agent up and ask for an explanation.

The agent explains that pre-approval is primarily used to estimate how much money a borrower can get on a mortgage based on self reported information. Underwriting goes a step further and requires specific documentation to prove to the lender that the borrower is a good credit risk. The underwriter is an employee of the lender and acts as a final gatekeeper to mortgage approval. Simply put, the underwriter's job is to make sure the lender doesn't lose money. Let's take a look at how the agent puts their mind at ease and explains the underwriting steps.

Underwriter Verification of Borrower Information

The underwriter seeks proof that the bank is not assuming too much risk. The borrower must have the income to make the payments each month. A strong history of making other payments on time is a good indicator of risk. The underwriter will request a number of items to show this proof.

Kevin and Mary should expect the lender to pull copies of their credit reports. The credit report will give both a score and a credit history. The score is based off a person's credit history. On time payments, different kinds of debts, and longevity of these accounts improve the score. Negative factors include problems like previous bankruptcy and foreclosures. The report will also verify information like prior addresses, employers, and any evictions or court judgments. Underwriters are looking for job and income stability. They will want explanations for any recent gaps or unusual changes.

Underwriter Verification of Property Details

As hinted at earlier, there is more to underwriting than certifying Kevin and Mary's financial health. The lender needs to ensure the property is good condition to serve as collateral and won't cause undue risk.

The underwriter will order an appraisal for the property. The appraisal is a professional opinion of market value given by a neutral third party. The appraisal ensures that the home is sufficient as collateral for the mortgage.

If Kevin and Mary don't make the mortgage payments, the lender will foreclose. The bank will have to sell the house to recover missing money from lost mortgage payments. If the mortgage amount balance is greater than the value of the house, the lender loses money. No one likes losing money. The lender reduces this risk by making sure the loan isn't upside down as soon as the home is bought.

Underwriters will want to see a survey of the purchase. They will send a surveyor to the property and bill Kevin and Mary at closing. The survey clearly defines the exact boundaries of the property. This can help identify any potential boundary disputes with neighbors or the local government before the purchase.

Insurance is a big issue in underwriting. The underwriter will need to receive a title insurance policy for the mortgage, paid for by the buyers. The title company will perform a search and certify that the property is free from any discrepancies that indicate an ownership dispute. The company backs the search up with insurance available for both the lender and borrower.

The lender policy is mandatory, but Kevin and Mary would be wise to buy a policy for themselves. That way if a long lost rightful owner reappears, they can be compensated for any loss from the title dispute.

The underwriter will also check if the property falls in a flood zone. If it does, the underwriter will need to see proof of a flood insurance policy. This is so the home can be insured and returned to its prior condition after a flood, which isn't covered by regular homeowner policies.

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