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Credit Underwriting

Guide to Underwriting Models

Guide to Underwriting Models

Guide to Underwriting Models

Guide to Underwriting Models

Guide to Underwriting Models

CATEGORY

FEATURED

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CATEGORY

FEATURED

Underwriting models vary depending on the type of loan being assessed. For small business loans, mortgages, and debt refinances, lenders commonly use specific models and frameworks tailored to the unique characteristics of each loan type. Below are the most commonly used underwriting models for these categories:

Underwriting Models for Small Business Loans

Cash Flow Underwriting:

  • Description: Focuses on a business’s ability to generate sufficient cash flow to cover loan payments.

  • Metrics: Debt service coverage ratio (DSCR), net operating income (NOI), and cash flow forecasts.

  • Use Case: Ideal for businesses with strong operational cash flows, such as service-based companies.

Collateral-Based Underwriting:

  • Description: Evaluates the value of collateral (e.g., inventory, equipment, or real estate) pledged by the business.

  • Metrics: Loan-to-value ratio (LTV) and collateral appraisal.

  • Use Case: Used for secured loans where tangible assets can mitigate lender risk.

Credit Score-Based Underwriting:

  • Description: Relies on the business owner’s credit score and credit history.

  • Metrics: FICO score, personal credit report, and payment history.

  • Use Case: Common for smaller loan amounts or startups without extensive financial histories.

Industry-Specific Models SMB Undewriting Models:

  • Description: Incorporates industry benchmarks and trends into risk assessment.

  • Metrics: Industry growth rates, sector risk levels, and competitive positioning.

  • Use Case: Tailored for businesses in high-risk or niche industries.

Alternative SMB Underwriting Data Models:

  • Description: Uses non-traditional data sources, such as utility payments, e-commerce sales, or social media activity.

  • Metrics: Transactional data, digital footprint analysis, and customer reviews.

  • Use Case: Designed for underbanked or unbanked businesses without traditional credit histories.


Underwriting Methods for Mortgage Lending

Automated Underwriting Systems (AUS):

  • Description: Digital systems used to assess mortgage applications based on predefined criteria.

  • Examples: Fannie Mae’s Desktop Underwriter (DU), Freddie Mac’s Loan Product Advisor (LPA).

  • Metrics: Loan-to-value ratio (LTV), debt-to-income ratio (DTI), credit score, and employment history.

  • Use Case: Standard for conventional, FHA, and VA loans.

Risk-Based Pricing Models:

  • Description: Determines interest rates and loan terms based on borrower risk.

  • Metrics: Credit score, LTV, DTI, and loan amount.

  • Use Case: Used for fixed-rate and adjustable-rate mortgages (ARMs).

Manual Underwriting:

  • Description: Involves human analysis for cases that fall outside automated system thresholds.

  • Metrics: Comprehensive review of borrower income, assets, employment, and liabilities.

  • Use Case: Common for borrowers with unique circumstances, such as self-employment or limited credit history.

Portfolio Underwriting:

  • Description: Loans held and serviced by the originating lender rather than sold to secondary markets.

  • Metrics: Customized criteria set by the lender, often more flexible than standardized models.

  • Use Case: Ideal for non-conforming loans or high-net-worth borrowers.


Bank Underwriting Models for Debt Refinances

Net Present Value (NPV) Analysis:

  • Description: Calculates the financial benefit of refinancing by comparing the present value of existing debt to the new loan terms.

  • Metrics: Discounted cash flow, interest savings, and closing costs.

  • Use Case: Common for evaluating mortgage or business loan refinances.

Credit Score-Based Models:

  • Description: Reassesses borrower creditworthiness post-original loan.

  • Metrics: Updated credit score, credit utilization, and payment history.

  • Use Case: Essential for unsecured loans or loans tied to personal credit.

Debt-to-Income (DTI) Models:

  • Description: Ensures the borrower’s income can support the refinanced debt.

  • Metrics: Monthly income versus total monthly debt obligations.

  • Use Case: Standard for consumer loan refinances, such as mortgages or personal loans.

Cash-Out Refinance Models:

  • Description: Focuses on the equity available in the underlying asset (e.g., home or business property).

  • Metrics: Loan-to-value ratio (LTV) and equity withdrawal percentage.

  • Use Case: Popular for mortgage and business property refinances.

Restructuring Models:

  • Description: Used for refinancing distressed loans to make repayment terms manageable.

  • Metrics: Revised repayment schedule, interest rate reductions, and principal adjustments.

  • Use Case: Common in commercial or real estate debt refinances for struggling borrowers.


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By understanding and selecting the appropriate underwriting model, lenders can tailor their assessments to the specific risks and characteristics of each loan type, ensuring sound credit decisions and better borrower outcomes.

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