Grasping the financing aspects of real estate is very important for any real estate investor. One such aspect is the process of real estate underwriting that mortgage lenders use. What is underwriting in real estate? How long does real estate underwriting take? And how does it affect getting a mortgage for an investment property? Keep reading as we answer all these questions in our detailed underwriting real estate guide.
Defining the Concept of Underwriting
Before delving into underwriting real estate, we must first define what underwriting is. In simple terms, this is a process that lenders use in order to assess the risk of giving out a particular loan. This includes everything from going over the potential borrower’s credit score to analyzing every aspect of their loan application. If the underwriting process doesn’t reveal any issues, the lender will issue the loan.
The Main Features of Underwriting Real Estate
While underwriting real estate is quite similar to its counterparts in other sectors, it also has some unique features. The real estate underwriting process requires a good grasp of the housing market and involves a wider scope of analysis. More specifically, lenders have to analyze both the borrower’s ability to repay the loan and the viability of the investment property itself. Here is how the typical underwriting process goes for a residential real estate investment.
1- Cash flow projections
The first step of the process is estimating the cash flow that the income property will bring. This is an integral part of real estate loan underwriting since it gives the lender a good idea of the investment’s ability to service the debt. In this step, the lender will look at various metrics such as effective gross income and net operating income. Income properties that are projected to generate positive cash flow are more likely to get investment loans.
2- An estimation of the potential return on investment
The second part of assessing the profitability of the investment property is estimating the potential return on investment that it offers. There are many ways to do this. One of the simplest ones is to simply divide the net operating income of the property by its appraised value or sale price. This will help the lender determine the cap rate of the investment property.
3- A review of the borrower’s credit history
Reviewing the borrower’s finances is just as important as property valuation. Moreover, each lender has different criteria when assessing investment property financing. But generally speaking, here are the main variables that lenders look at when reviewing credit history:
- Payment history
- The amount of outstanding debt
- Credit use history
- A long track record of responsible use of different sources of credit
- The real estate investor’s debt to income ratio
After a careful look at all of these variables, the lender assigns the borrower a credit rating. Investors who fall below the lender’s baseline rating will be rejected.
What Real Estate Investors Need to Know About Underwriting Real Estate
As you can see, underwriting real estate is a complex process that involves several moving parts. It is worth noting that lenders are very conservative when analyzing the risks of real estate transactions. Consequently, real estate investors have to make sure that every aspect of their application is in order. Needless to say, getting good investment property mortgage rates is predicated on meeting the lender’s requirements.
Here are a few tips that can help maximize the chances of loan approval when buying investment property.
1- Be ready to share all details of your finances with the lender
Keeping information from the mortgage lender is one of the worst mistakes that you could make. Lenders like to have a complete idea of your financial situation. To that end, it is essential that you provide every document that pertains to your income. Examples of this include tax returns, pay stubs, verification of accounts, and verification of employment.
2- Have your collateral appraised by a professional
The value of the collateral is what ultimately entices the lender to issue the loan. Grasping the basics of mortgage lending and property appraisal is therefore imperative. When underwriting real estate, lenders will try to set terms that are favorable to their firm. The loan that they issue is typically determined by the LTV ratio (loan to value). Taking this into account, real estate investors need to properly appraise their investment property before applying for a loan.
3- Make sure to submit all the required documents
Having a loan application rejected because of incomplete documentation is not something you want to deal with. To avoid this, you need to make sure that every relevant document is included. Documents that pertain to property valuation and verification are especially important. Applications that don’t contain title search documents or No Objection certificates will be swiftly rejected.
4- Make a strong impression on the lender
Underwriting real estate is not just a matter of data and paperwork. As a matter of fact, there is an undeniable human element to the process. Lenders are more likely to entrust their funds to assertive characters. Furthermore, investors who can explain their real estate investment strategy in an articulate and confident manner can easily gain the trust of the lender.
How Long Does the Process Take?
Since this is one of the final steps of loan approval, timing can be crucial when closing on a real estate investment property. In most cases, underwriting real estate takes up to one week. The most effective way to speed up this process is by including all the required documents in the initial application. Lenders prioritize applications with complete documentation, which can lead to quicker processing time.
The Bottom Line
The process of underwriting real estate might seem intrusive and tedious. However, it is crucial to remember that this is the last hurdle you have to clear. Once you get past this final step, you will be able to finalize your investment right away.