Introduction: Quick Definition
The most common example of underwriting is when a bank or financial organization offers an individual a loan. This loan can be for a car, a home, or to pay down debt. However, underwriting can also be applied to insurance or investments.
Simply put, underwriting is the process in which a lender takes on an individual’s financial risk. So, if an individual seeks to receive a mortgage loan, the individual must meet with a banker and fill out their application. The underwriter’s job is to determine the individual’s risk level—their ability to pay back their loan to the financial institution—based on their application.
If accepted, the lender will always charge the individual a fee for taking on this risk, which takes one of three forms:
- A down payment
Sometimes all of these fees will be collected for higher-risk acceptances.
Underwriters also may require the borrower to work with a co-signer to minimize the risk of default.
Qualifications an Underwriter Appraises
Underwriters look for the following things to see if a client passes the minimum risk-assessment qualifications.
- Credit history
- Financial records
- Collateral Value (if collateral is required)
- Loan Size
- Income to debt ratio
- Total income
- Previous mortgages
- Total Net Worth
- Health (if applying for insurance)
Types of Underwriting
There are several types of underwriting. While automated systems have overtaken some of these processes, there are still plenty of jobs for underwriters in the financial industry. These include:
This kind of underwriting is the process with which most people are familiar. This underwriting requires the underwriter to possess a knowledge of house market value, assessing individual net worth and liabilities, as well as the ability to turn around a risk-assessment decision within a week. Occasionally the mortgage underwriter will also have to work through refinancing paperwork.
The main focus for insurance underwriting is on the insurance’s recipient—particularly recipient health. Many insurance companies will have their underwriters deny applicants who have dangerous pre-existing conditions because they represent a high-risk with a low-return value.
This kind of underwriting is most commonly used in IPOs but can also include individual stocks or government and corporate bonds.
An underwriter’s task is to assess the risk an individual or company poses to the underwriter’s corporation. If the applicant proves to be likely to pay back both the loan and interest without default, the applicant will usually be accepted. There are certain circumstances in which an underwriter will approve a higher-risk application. Still, in general, an underwriter will perform a numbers-based risk assessment, which will determine the likelihood of an individual’s application acceptance.