A typical real estate deal has so many moving pieces, information can easily get lost, and you along with it. Amid market swings, technical developments and improvements to the homebuying sector, today’s buyers need to pay special attention to ensure that nothing slips through the cracks.
One part of the acquisition process — real estate underwriting — specifically exists to help buyers (and lenders) prevent possible risky deals. Read through the following guide before making your next deal, and learn how to make the best use of real estate underwriting for successful real estate ventures.
What is Real Estate Underwriting?
Real estate underwriting is the mechanism whereby a loan application is checked to assess the amount of risk involved. The underwriter must look at the financial status of the borrower and the valuation of the property at hand to determine the deal’s potential. Underwriting is an integral part of the acquisition process because it can allow both lenders and investors to bypass failed assets.
Simply put, you can think of real estate underwriting similarly to the pre-approval process for a loan. Both examine the finances of a borrower to determine the feasibility of an arrangement. The difference is that underwriting precisely takes into account the degree of risk involved, and also needs additional details from the borrower to do so. Lenders don’t necessarily need this thorough process, and many investors can simply learn how to underwrite a deal themselves (with a financial advisor’s guidance).
The definition of underwriting is the process of accepting liability when an investment is made, and ensuring payment in case of loss or damage. Underwriting is not exclusive to real estate and can be used for loans, investments or insurance of any type. Underwriting, according to Investopedia, arose from a method where investors will leave a signature below the amount of risk they are willing to take on in a given contract. Although the method is much more systematic now, this type of risk assessment still associates with the word underwriting.
What Does an Underwriter Do?
The role of an underwriter is to research the borrower and the investment in order to determine a loan’s security. The debt service coverage ratio (DSCR) is one of the key considerations they’ll look at. This measure is determined by revising an investment’s net operating profit compared to the overall amount of the loan. This will essentially reveal if the profits made from the investment are sufficient to repay the loan. Along with a few other factors, the underwriter will use this information to determine whether or not a loan should be approved.
Moreover, it is the duty of the underwriters to ensure that there is adequate collateral to fund the future loan. Most immovable loans will use the property as collateral, which means the lender could seize the property in case of default. This includes ensuring, for the real estate underwriter, that the valuation of the property does not surpass the loan sum. The underwriter will use the amount of the valuation to assess the size of the loan. The underwriter will probably not approve financing if the loan exceeds the property’s appraisal value for some reason.
How Does the Real Estate Underwriting Process Work?
The underwriting process for real estate will start one of two ways: when a loan application is submitted, or when an investor wants to complete the underwriting for a potential transaction. Most commonly, a lender will initiate the underwriting once a borrower submits a loan application. In fact, many traditional lenders will require underwriting before they issue a mortgage loan. Underwriters would need to the borrower to submit identifying documents and credit reports in order for the underwriter to complete a detailed evaluation. The underwriter will then request an assessment of the land.
It may take somewhere from a few days to a week to complete a typical underwriting process. The longest portion must ensure the correct paperwork is submitted promptly. Any borrowers looking to speed up this should prepare the necessary paperwork in advance and should be attentive to their lender’s communications. The final step in the process is decision making and reviewing any conditions for approval which can lead to successful investments.
Also, real estate investors looking to assess deals themselves may complete the real estate underwriting process. This includes looking through a careful contract analyzer at the property numbers. Factors to look at include net profits from sales, return on investment and more. Investors who choose to underwrite their own deal will then have a third party (typically a broker or financial advisor) review it. Next, investors must predict future situations and schedule results and likely outcomes. To be clear, underwriting yourself isn’t a way to get a loan approved. Instead, it is another tool which can be used in a potential deal to assess risk.
In any given deal, as investors seek to adapt to the changing real estate industry, it may be easy to overlook the smaller features. But, what separates experienced businessmen from their peers is commitment and a close attention to detail. Before you enter your next house, whether residential or commercial, familiarize yourself with the underwriting of immovables. This process can help you avoid risky investments and find successful additions to your portfolio in a quicker manner.