FAQs About Loan Underwriting At Banks
Loan Underwriting FAQs
What is loan underwriting?
Loan underwriting is the process of evaluating a borrower's creditworthiness and the overall risk of a proposed loan. Underwriters review financial information, repayment capacity, credit history, collateral, loan purpose, and other relevant factors to determine whether the loan meets the bank's lending standards.
What is the primary purpose of underwriting?
The purpose of underwriting is to determine whether a borrower can reasonably repay the loan and whether the proposed credit structure presents an acceptable level of risk to the bank.
What factors do underwriters consider?
Depending on the loan type, underwriters may consider:
- Credit history and payment performance
- Income and employment
- Debt obligations
- Debt-to-income ratio
- Cash flow and repayment capacity
- Assets and liquidity
- Collateral
- Loan purpose
- Loan amount and term
- Existing relationship with the bank
- Applicable lending policies and requirements
What is repayment capacity?
Repayment capacity is the borrower's ability to generate sufficient income or cash flow to meet scheduled debt obligations while maintaining an appropriate level of financial stability.
What is the debt-to-income ratio (DTI)?
DTI compares a borrower's recurring debt obligations with income. Banks may use DTI as one factor in evaluating repayment capacity, subject to the requirements applicable to the particular loan.
What is a credit score?
A credit score is a numerical assessment derived from information in a consumer's credit history. It may be used as one factor in evaluating a consumer credit application.
What is credit history?
Credit history provides information about a borrower's prior use of credit, including payment history, outstanding obligations, account history, and other information contained in applicable credit reports.
What is collateral analysis?
Collateral analysis evaluates the type, value, condition, ownership, and marketability of assets pledged to secure a loan. The analysis also considers the bank's ability to establish and maintain an appropriate security interest.
What is loan-to-value (LTV)?
LTV compares the loan amount with the value of the collateral securing the loan. It is commonly used in secured lending to evaluate collateral risk.
What is debt service coverage ratio (DSCR)?
DSCR measures the amount of cash flow available to cover required debt payments. It is commonly used in commercial lending and certain other credit analyses.
What is loan risk rating?
A loan risk rating is an assessment of the level of credit risk associated with a loan or borrower. Banks may use risk ratings to support credit decisions, monitoring, portfolio management, and allowance or credit-loss processes.
What is a loan policy?
A loan policy establishes the bank's standards and requirements for originating, underwriting, approving, documenting, monitoring, and managing credit. Underwriters should ensure loan decisions are consistent with applicable policies.
What is an underwriting exception?
An underwriting exception occurs when a proposed loan does not fully meet an established lending standard or policy requirement. Exceptions should be appropriately documented, justified, approved by authorized personnel, and monitored according to bank procedures.
What is an approval authority?
Approval authority defines the types and amounts of credit an employee or committee is authorized to approve. Transactions exceeding an individual's authority must be escalated to the appropriate approval level.
What is an independent credit review?
Independent credit review evaluates loans or lending decisions separately from the original underwriting function. It can help identify weaknesses in underwriting, policy exceptions, risk ratings, documentation, and portfolio management.
How does fair lending apply to underwriting?
Underwriting decisions must comply with applicable fair lending laws. Banks should apply legitimate credit criteria consistently and avoid using prohibited characteristics or other impermissible factors in credit decisions.
Can an underwriter consider a borrower's age?
Age may be relevant in limited circumstances permitted by applicable law, but it generally cannot be used as a prohibited basis for discrimination in covered credit decisions. Underwriters should follow applicable law and bank policy.
What documentation should support an underwriting decision?
The loan file should contain sufficient documentation to support the credit decision, including relevant financial information, credit analysis, collateral information when applicable, approval documentation, and any required exceptions or conditions.
What are underwriting conditions?
Conditions are requirements that must be satisfied before a loan can close or fund. They may include obtaining additional documentation, verifying information, completing collateral requirements, or satisfying other credit or compliance requirements.
What is a credit memo?
A credit memo is a written analysis summarizing the proposed credit, borrower information, financial condition, repayment capacity, collateral, risks, mitigating factors, structure, and recommendation.
What is cash-flow analysis?
Cash-flow analysis evaluates the sources and uses of cash and determines whether the borrower generates sufficient cash to meet operating needs and debt obligations.
What is sensitivity analysis?
Sensitivity analysis evaluates how changes in assumptions—such as income, expenses, interest rates, occupancy, revenue, or collateral values—could affect the borrower's ability to repay the loan.
What is stress testing in underwriting?
Stress testing evaluates how a loan or borrower may perform under adverse conditions. Examples may include higher interest rates, reduced revenue, increased expenses, declining collateral values, or economic downturns.
What is a guarantor?
A guarantor is an individual or entity that agrees to be responsible for specified borrower obligations under a guaranty. The scope and enforceability of the guaranty depend on the loan documents and applicable law.
What is a personal financial statement?
A personal financial statement provides information about an individual's assets, liabilities, income, and financial condition. It may be used to evaluate guarantor strength or repayment capacity.
What is a global cash-flow analysis?
A global cash-flow analysis evaluates cash flow across multiple related entities, individuals, or sources of income to assess the overall capacity supporting a credit relationship.
What happens when an underwriter identifies a material discrepancy?
The discrepancy should be investigated and resolved through appropriate verification procedures. Material discrepancies should be documented and escalated when necessary before a final credit decision is made.
What happens if a borrower does not meet underwriting standards?
The loan may be declined, restructured, or approved with appropriate conditions or exceptions if permitted by policy. Any decision should be supported by legitimate, documented credit considerations and comply with applicable lending laws.
Why is documentation important in underwriting?
Complete and accurate documentation provides evidence supporting the credit decision, promotes consistent underwriting, facilitates audits and examinations, and helps the bank monitor and manage credit risk.
What should an underwriter do if they are pressured to approve a loan that does not meet requirements?
The underwriter should follow established approval and escalation procedures and document relevant concerns. Employees should not circumvent underwriting standards or approve credit outside their authority.
What should employees do if they suspect fraud during underwriting?
Potential fraud, falsified documents, misrepresentations, or other suspicious activity should be promptly escalated through the bank's established fraud, BSA/AML, compliance, or management procedures.
Why is consistency important in loan underwriting?
Consistent underwriting helps ensure that similar borrowers are evaluated using appropriate and comparable criteria, supports sound credit decisions, reduces operational and compliance risk, and promotes fair lending practices.
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