Definition of Underwriting
In the mortgage industry, underwriting is the process of assessing the risk of providing a mortgage to a prospective borrower on a certain piece of property.
Just as an insurance company will assess the risk of insuring an individual, a mortgage company will assess the risk of the applicant and the property that is the subject of the mortgage, prior to issuing a loan. In regards to a mortgage transaction, the underwriting process is two fold: An assessment of the risk of loaning money to a particular borrower as well as taking a certain parcel of real estate as collateral for a loan.
Underwriting is normally performed by an employee of the lender, or a company retained by the lender to perform the service. The Real Estate Institute of Canada provides specialized education and training for the designation of Certified Residential Underwriter (CRU). Mortgage companies will also determine their own particular guidelines and formula for determining the risk of the mortgage applicant in addition to standard regulations.
Assessment of the Applicant
A number of factors will be used to determine the risk of the mortgage applicant. Some of the more important factors include the following:
- The credit worthiness of the applicant, usually determined via a credit score and the credit behaviour reflected on a credit report;
- The past and present income of the applicant;
- The applicant's net worth
The current monthly budget of the applicant, including payments for other outstanding monthly installment debt.
These factors will be used to determine whether the applicant is capable and willing to repay a mortgage loan, and if so, for how much. The less credit-worthy and higher risk the applicant demonstrates will generally mean less favorable terms for the loan, including a higher interest or additional collateral being required. A mortgage underwriting may require additional documentation to verify the information of the applicant, or to answer questions raised in the underwriting process.
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Assessment of the Property
Because the mortgage holder is taking real estate as security for repayment of the mortgage loan, an assessment of the property is also required. Normally, the value of the property is determined through a formal appraisal, performed by a licensed real estate appraiser. The appraiser will assess the property, research the market area and determine a fair market value of the property in question. If a borrower is applying for a mortgage that will be insured by a mortgage default insurance company, such as CMHC, the insurer will often used their own, patented appraisal system to assess the property and a formal appraisal may not be required.
As part of the underwriting process, mortgage lenders will need to ensure the following in regards to the subject property:
- The property is being sold at fair market value;
- It is in saleable condition;
- The property is indeed located where it is stated to be on the mortgage application;
- It is currently owned by the sellers listed on the purchase contract;
The title is unencumbered by title defects.
The acceptability of the appraisal or the condition of the title can affect the potential of the mortgage loan. If the appraisal is substantially less than the proposed property value, the lender may not, or cannot, issue the mortgage depending on the required mortgage. If the title to the real estate is in serious doubt or is unclear, the mortgage lender may also not be able to extend the mortgage loan.
At First Foundation, our education, training and experience has allowed us to be familiar with underwriting standards for mortgage loans, both in assessing the risk of the individual and the subject property. We can often anticipate in advance, the question lenders will ask or the documents to be required by the applicant, allowing your mortgage application to go through the underwriting process as quickly as possible.
If you are interested in learning more about underwriting, please feel free to contact us today!