• Underwriting in real estate refers to the process of assessing risk potential before approving a loan, investing in a property, issuing an insurance policy, or packaging real-estate-based securities.
  • Mortgage underwriting is especially important for homebuyers and their lenders. This process analyzes the buyer’s ability to repay the loan as well as the property’s suitability as collateral for the loan.   
  • Some risks uncovered in the mortgage underwriting process can be mitigated through creative solutions, such as increased interest rates, higher down payments, co-signers, guarantors, or additional insurance requirements. 

Whether you’re buying a home for the first time, “right-sizing” to a house that meets your changing needs, borrowing against your home equity, refinancing your existing mortgage, or purchasing an investment property, the underwriting process assesses risk to determine if the transaction makes sense.

Underwriting plays a critical role in real estate, ensuring that loans, investments, insurance policies, and securities are structured to minimize risk. By carefully analyzing borrower qualifications, property value, and market conditions, underwriters help protect all parties involved, while also making room for creative solutions to manage risk. 

What is Underwriting in Real Estate?

Underwriting is the process of evaluating potential risks and mitigating them by tailoring the terms of the agreement governing the deal.[1]

For example, before issuing a home loan, a mortgage lender must complete the underwriting process to assess the risk in lending funds to the borrower for that property. If there is a higher risk that the borrower could default on the loan or the property could suffer damages, the lender may increase the interest rate to offset some of that increased risk. 

Underwriting is critically important in real estate because it can uncover risks and provide an opportunity for individuals and companies to walk away from a potentially bad deal or customize the terms of the agreement to account for any additional risk. 

Types of Real Estate Underwriting

There are four primary types of underwriting in real estate:

1. Mortgage Underwriting

Mortgage underwriting assesses the risk related to lending money to a borrower to purchase property. This information helps determine interest rates, down payment requirements, and loan terms. 

Banks and mortgage lenders may have in-house underwriters or may hire a third-party company specializing in underwriting. Automated Underwriting Systems (AUS) may also be used. If the borrower is applying for a government-backed mortgage (like an FHA, VA, or USDA loan), there may be additional underwriting requirements, which could be reviewed by a government-approved underwriting.   

2. Investor Underwriting

Investor underwriting evaluates the risk associated with investing in a real estate project, such as a new development or a long-term rental purchase. This information is used to determine whether the project meets the investor’s criteria. 

Private investors, institutional investors, and real estate funds may conduct underwriting personally or engage third-party specialists.

3. Insurance Underwriting

Insurance underwriting in real estate assesses the risk related to insuring a specific property. This evaluation helps determine insurance policy terms, coverage limits, and premiums. 

Insurance underwriting is typically conducted by the insurance company or a third-party representative. 

4. Securities Underwriting

Real estate securities underwriting assesses the risk and viability of issuing real estate-backed securities, such as mortgage-backed securities (MBS) or real estate investment trusts (REITs). 

Investment banks, financial institutions, and brokerage firms may conduct the underwriting process in-house or hire third-party underwriters. The process involves evaluating the underlying real estate assets and market conditions.

How Mortgage Underwriting Works in Real Estate 

Mortgage underwriting is a complex process involving extensive research into several factors that determine the risk level of loaning money to a given borrower for a specific property. 

Factors Considered in the Mortgage Underwriting Process

Underwriters consider factors relating to the borrower as well as factors relating to the property when calculating risk. 

Borrower-Related Factors

Underwriters analyze borrowers’ financial records to determine their likelihood of repaying their loans. This includes a review of creditworthiness and financial readiness.

Creditworthiness

The underwriter pulls the borrower’s credit history to determine how responsibly the borrower has handled debt. 

Credit scores are calculated based on the following:[2]

  • History of paying bills on time
  • The current amount of unpaid debt
  • The number and type of loan accounts active
  • How long accounts have been open
  • How much of the available credit is being used
  • Whether there are any recent applications for new credit lines
  • Whether the record contains accounts in collection, a foreclosure, or a bankruptcy

Many credit scores range between 300 and 850, with higher scores indicating a lower risk for the lender. Minimum credit score requirements vary by lender. However, it is common to require at least a 600 for FHA loans and 620 for conventional loans.  

Financial Readiness

The underwriter estimates a borrower’s financial readiness to take on a mortgage loan by evaluating factors such as:

  • Income: Does the borrower earn enough to comfortably repay the debt? Is this income stable and expected to remain so for the foreseeable future?  
  • Savings: Does the borrower have cash available to complete the purchase and still have money left over in case unexpected expenses were to arise? 
  • Assets: Does the borrower own items of value, including investment accounts, retirement accounts, or other properties that can be sold/liquidated if the borrower faces a financial hardship?
  • Debt: How much of the borrower’s income is allocated to debt? This figure is known as the debt-to-income ratio (DTI). 

Each factor affects the risk level of loaning funds to the borrower. Generally, higher income, higher savings, higher assets, and lower debts indicate less risk for the lender.

Property-Related Factors

Lenders are invested in the property the borrower purchases because the property serves as collateral to secure the home loan. If the borrower were to default on the loan, the lender could foreclose and sell the property to help recover losses. So lenders assess property-related risks like the following.  

Value of the Property

The underwriter confirms the current value of the property being purchased, typically relying on a home appraisal completed by a licensed real estate appraiser.

To avoid assuming too much risk, lenders typically set limits regarding how much of the property’s value can be financed. This is called the loan-to-value (LTV) ratio. For example, a lender may be willing to offer an LTV of up to 97% for a well-qualified homebuyer. This would allow for a down payment of as little as 3%.

Condition of the Property

The lender may have requirements relating to the property's condition, particularly if the buyer is using government-backed financing. For example, a property purchased with a VA loan would need to meet the VA’s minimum property requirements.[3]

Risk of Damages or Losses from Natural Disasters

An underwriter reviews recent natural disasters in the area to assess the potential risk posed by phenomena like earthquakes, flooding, high winds, landslides, and hail.

Clear Property Title

The underwriter may also work with a title researcher to explore the property’s chain of ownership. They are looking for any indication that anyone other than the seller has a legal claim to the property (a cloud on title). 

Common clouds on title include:[4]

  • Ownership disputes caused by marriage, divorce, or inheritance
  • Public record errors
  • Liens caused by unpaid debts
  • Boundary disputes

Clouds on title must be resolved before the deal can proceed.

Profitability Potential 

If the property being financed is to be used as an income-generating rental, the underwriter may use local rental rates and vacancy rates to determine the income potential and any risk to this income. 

How Lenders Mitigate Risks Uncovered Through Underwriting

If the underwriter finds that the risk exceeds the lender’s preferred range, the lender can take any number of actions to mitigate the risk. For example, they can:

  • Increase the interest rate. A higher interest rate could make the extra risk with the lender’s while.
  • Decrease the loan amount. By reducing the loan amount, the lender would require the borrower to increase the down payment. This effectively shifts more of the risk from the lender to the buyer. 
  • Allow a co-signer or guarantor. Co-signers are jointly responsible with the borrower for repaying the debt, while guarantors agree to repay the debt if the borrower defaults. This added assurance of payment reduces the risk for the lender. 
  • Request repairs to the property. Concerns about the condition of the property can be addressed by having the seller repair the issues causing concern.  
  • Require additional insurance. Lenders may require special insurance policies, such as flood insurance, for properties with higher-than-average risk of damage from natural disasters.  
  • Deny the loan application. If the lender cannot find a way to mitigate the risk, they may deny the loan application. The borrower may be granted a loan for a lower-risk property, or they may need to improve their credit or finances before they can be approved for a mortgage. 

The Bottom Line

The underwriting process involves a thorough evaluation of potential risk factors with the intention of preventing individuals and businesses from taking on too much risk. Mortgage underwriting, in particular, often prevents homebuyers from overextending themselves or purchasing a problematic property. While some high-risk factors cannot be accommodated, others can often be offset through measures like increased interest rates, decreased loan amounts, co-signors, guarantors, or additional insurance. 

If you are buying a home, ask your lender about their mortgage underwriting process.