In simple terms, underwriting is determining the possibility of a borrower paying what he has promised. The other aspect of it is checking if adequate collateral is available in the case of a default. When insurance is concerned, underwriting assesses the health of a policyholder, and the risk is spread equally among different people.
Investors largely depend on underwriting as it depicts if it’s worthy enough to take the business risk. Moreover, the process also contributes to salesy activities. For instance, while the initial public offering or IPO, underwriting professionals buy the entire issue, which is later sold to investors.
A Brief History Of Underwriting
Have you ever applied for mortgages, a car loan, or an insurance policy? If yes, your application has most likely gone through an underwriting process. This process is not only detailed and intense but also a bit rigorous. Let me brief you on its history a bit.
The term “underwriter” exists from the “Lloyd’s of London” story. It has to be the oldest insurance firm that is still going strong. The Lloyd’s of London actually began as a coffee house in London’s shipping district. Underwriters were the heroes behind the whole underwriting process, and they generally existed on the bottom line.
Underwriters provided their personal guarantee along with talking liability for all the decisions that were made. In case the merchant ships went down, it was the sole responsibility of the underwriters to pay the claims mentioned in the insurance contract. They performed their role very seriously since a small decision can incredibly impact them.
At present, the guidelines for this process are identified by the FHA or Federal Housing Administration. There are other administrative bodies too, like the “Rural Housing Service,” and the “ Veteran’s Administration.” Various underwriting entities take up the responsibility and reduce the load from the shoulders of insurance agencies.
Well, the good news today is that mortgage industries and banks have some liabilities. For instance, in case the mortgage suffers a default owing to some negligence by the mortgage company, the authorities will take care of it. Here, the mortgage industry will reincur all damages. This is why underwriting is a detail-oriented process.
How Do The Various Underwriting Types Work?
Irrespective of the underwriting types, decisions are made only after the degree of risk is assessed. Generally, we talk about these three common types of underwriting:
1. Securities Underwriting
When it comes to assessing risks and the correct price of a specific security, one seeks securities underwriting. It is mostly associated with an IPO and is carried out on behalf of prospective investors or an investment bank. It is the outcomes of underwriting which assist an investment bank in making a decision on buying securities.
Most of which is issued by the agency opting for the IPO. Furthermore, the securities form of underwriting includes debt securities and individual stocks. Underwriters buy these securities and resell them at a profitable price either to dealers or investors. If there is more than a single underwriter involved in the process, we call it an “underwriter syndicate.”
2. Loan Underwriting
Home loans, car loans, education loans- almost every loan goes through the process of underwriting. Mostly, the procedure is automated and includes appraising the credit history of an applicant. What later goes into consideration is his financial records, the collateral value offered, and other such factors associated with the loan.
Mortgages are the most commonly found loan underwriting type that needs a human underwriter. Maximum people experience this where it assesses liabilities, credit history, savings, income, and much more. Mortgage underwriting generally has one week’s “turn time,” or sometimes even less. What takes a bit more time is refinancing, as buyers facing deadlines acquire preferential treatment.
3. Insurance Underwriting
As soon as insurance underwriting comes into being, the focus shifts to potential policyholders. These are individuals seeking either life or health insurance. Previously, medical underwriting in health insurance determined the exact amount an applicant must be charged. The determining factor was their health and their pre-existing conditions.
Before 2014, there was no allowance for insurers to say no to coverage or exercise limitations on pre-existing conditions. Underwriting for life insurance seeks to assess the challenges of insuring a policyholder depending on their health, age, lifestyle, history, and occupation. Life insurance underwriting usually leads to approval having a plethora of coverage prices, exclusions, and conditions.
Inclusions In The Underwriting Process
The process is directly related to evaluating your previous credit decisions as well as finances. During underwriting, the underwriter investigated four major areas that offer them a complete picture:
In order to opt for insurance or a mortgage, you must have adequate income. In order to prove this, an applicant has to provide certain documents like:
- W-2s belonging to the past 2 years
- Two latest bank statements
- Recently paid stubs
The underwriter further checks whether or not your income aligns with the one you reported.
Secondly, the underwriter keeps track of the credit score. This three-digit number shows how responsible an individual is while paying back debt. An ideal credit score presents that he/she has paid all their debts on time which ultimately qualifies for a reduced interest rate.
Information On Assets
Did you know that your assets play an important role in getting your insurance or mortgage approved? The reason is that if you face defaults on your payment, these can be sold in exchange for cash. The underwriter usually views your savings as well as checking accounts, personal assets, stocks, and real estate.
While purchasing a home, appraisals are usually needed. They offer protection to both you and the lender as they let you borrow only what’s needed. The appraiser will further inspect the property and take correct measurements and pictures for you. After the property is placed a value by the appraiser, the underwriter checks your mortgage amount and compares both.
Underwriting is just another word that your dedicated lender will verify your assets, income, and debts to approve your loan. This financial expert takes a brief look at all your finances and checks what amount of risk is worth taking on offering you the insurance or loan.
We suggest you respond actively throughout the process of underwriting to your lender. They operate in different realms of finance, which is why they have an extended knowledge of the topic. Not only the mortgage industry but the equity markets even need them to spread out the risks evenly.
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