Loan Pre-Underwriting and Underwriting 101

Loan Underwriting and Pre-Underwriting in Real Estate: What do homebuyers need to know?

Navigating the complex world of real estate transactions can be intimidating, particularly when it comes to securing financing as a soon-to-be homebuyer. In your home search and loan process journey you may start hearing the terms loan underwriting and pre-underwriting and be wondering what they mean to you as a homebuyer.

We will break down the definitions of each of these concepts and go into the details on what impact these have on your home search and financing options.

What is Loan Underwriting?

Loan underwriting is the part of the homebuying process where lenders determine how risky it would be to lend money to a potential borrower. Essentially, this is the step in your home financing journey where your mortgage lender determines whether or not you are a high risk candidate for a mortgage loan.

The loan officer will look at items like your credit report, credit score, creditworthiness, debt-to-income (DTI) ratio, pay stubs, tax returns, bank statements, etc. to determine how risky it would be to lend you money.

During underwriting, the lender will review the borrower's credit history, income, assets, and other factors to determine their ability to repay the loan. Based on this information, the lender will decide whether the borrower can make the monthly payments, whether to approve the loan, and at what interest rate it would be approved.

What is Pre-Underwriting?

Pre-underwriting, which is sometimes referred to as conditional underwriting, is an extra step that some loan officers or mortgage servicers will take before the formal underwriting process begins on a mortgage application.

During pre-underwriting, the lender and mortgage company typically review the borrower's financial information from the loan origination and issue a pre-underwriting decision, which is the initial determination of whether or not the borrower will likely be approved for a loan. Pre-underwriting will also take a loot at the home purchase price and any closing costs and down payment amounts needed to determine the approval.

Pre-underwriting vs Pre-qualification and Pre-approval

Pre-underwriting is not the same as pre-approval. Pre-approval is a simpler process that involves a preliminary review of the borrower's financial information to determine the maximum loan amount they can qualify for. Pre-approval does not involve a full underwriting review and does not guarantee loan approval.

Pre-underwriting is not the same thing as pre-qualification or pre-approval, though. The main difference between the three is the level of assessment of the borrower’s finances, as pre-underwriting involves a very detailed and more comprehensive deep dive into the financials of the potential homeowner.

Pre-qualification, on the other hand, is the preliminary self-report done upfront in the loan process by the borrower to see if they would qualify for financing, and then pre-approval is the step to determine the highest loan amount that a borrower could potentially qualify for from a lender.

Pre-approval and getting pre-qualified does not include having a lender perform an underwriting review and again, this does not mean that the loan approval is guaranteed for the borrower.

When is pre-underwriting necessary for a homebuyer?

There are a number of situations where pre-underwriting and the mortgage underwriting process might be necessary for the borrower, some are listed below:

1. Complicated Finances: If the borrower is self-employed or has multiple sources of income or irregular income streams then they would likely need to go through pre-underwriting to ensure that they are financially fit for the new home loan
2. Borderline Loan Eligibility: If the borrower is on the cusp of being eligible for other FHA or conventional loan approvals by a lender, then they will likely need a further financial deep dive
3. Large Loan Amounts: For borrowers who have a loan application in for a large amount or are looking at higher purchase price homes, pre-underwriting may be required to make sure they are actually able to repay the higher loan amounts
4. Non-Traditional or Special Circumstance Borrowers: Special circumstances include being a first-time homebuyer, buyers with limited credit history or bad credit card debt, or borrowers with other unique financial problems (ex: foreclosures or past bankruptcy), may require pre-underwriting to assess their eligibility and loan terms based on the additional documentation provided
5. Government Loans or Specific Property Loan Programs: Certain types of loan programs, such as government-backed mortgages or down payment assistance programs and specific property type programs may require borrowers to go through a more in-depth analysis of their finances.

It is important to note that most mortgage lenders will closely follow the loan underwriting rules spelled out by Fannie Mae and Freddie Mac. There are a number of other scenarios where a potential homebuyer may need to go through a pre-underwriting process with their mortgage application, so be sure to check with your lender for your unique buying situation.

If you have any questions or you’re ready to start your home search, Aalto is here to help. We’re dedicated to demystifying the real estate process and providing you with the tools you need to buy or sell your home. Get started on aalto.com.