Underwriting

Each loan application undergoes underwriting. During this process, a lender evaluates a loan application, determines its associated risks, and decides whether they’re willing to issue the loan and at which terms.

Read on to learn more about the underwriting process, how it works, and how it relates to hard money loans.

What Is Underwriting?

Underwriting is the process through which lenders assess the risks associated with issuing loans. During underwriting, financial institutions and private lenders analyze a borrower’s assets and evaluate their ability to repay their loan. Through this process, lenders determine the exact terms they’re willing to issue for a loan, including the loan amount, interest rate, duration, and other essential aspects of the loan.

How Does Underwriting Relate to Hard Money Loans?

Like all loans, underwriting is an essential step in hard money loans. While lenders may look at credit score, employment, or other financial details, hard money lenders focus on the borrower’s collateral property and exit strategy to assess risk during underwriting.

How Underwriting Works

How exactly does a borrower’s collateral property and exit strategy play into the hard money loan underwriting process? Let’s take a deeper look:

Step 1: Property value

First, a hard money lender assesses the as-is value of the collateral property. They’ll often look at comps currently on the market to determine its value.

Step 2: Existing loans

They’ll also look at any existing loans or outstanding debts already in place on the property to determine their ability to recoup their losses.

Step 3: Exit strategy

Lenders also want to assess the viability of a borrower’s exit strategy, or how they’re planning to pay off a loan. Exit strategies may include fix-and-flip sales, rental income, existing property sales, or any other methods through which borrowers plan to come up with the funds to pay back their loans.

Step 4: LTV

Then, lenders determine the loan amount using a ratio known as LTV (loan-to-value). This is a ratio of the loan amount vs. the property value. Source Capital offers LTVs of 65% on first-position loans and 50% on second-position.

Step 5: Loan terms

Finally, they’ll determine loan terms based on the assumed risk associated with the loan.

Real‑World Scenarios

Let’s take a look at real-world scenarios for a deeper understanding of the underwriting process.

Commercial Hard Money Loan

An investor applies for a commercial hard money loan to purchase a new, 10-unit office building. They use an existing office building as collateral. They’re seeking a hard money loan of $1 million. Their exit strategy is to use rental income from the 10 offices to pay back the loan.

The hard money lender conducts underwriting. They determine that the collateral property is worth $2 million. They also find that there’s ample demand for office space in the area. Based on these factors, the lender determines this loan to be low risk and approves the application.

Fix-and-Flip Loan Rejection

An investor seeks a hard money loan of $500,000 to purchase, renovate, and sell a dilapidated property in their area. They submit information about the property they intend to use as collateral, the property they intend to purchase, their planned renovations, and their exit strategy (selling the renovated property) to the lender.

During underwriting, the lender determines their collateral property is worth $700,000, meaning a $500,000 loan would have a 72% LTV. They also look at homes in the area that are comparable to the desired property after its future renovations. They determine that similar homes have sold for an average of $400,000, which wouldn’t be enough to pay back the loan. Based on these figures, they determine the loan is too risky and reject the application.

Underwriting FAQs

How is underwriting different in hard money loans vs. traditional loans?

In traditional lending, lenders focus on financial details during underwriting. A lender will assess credit score, employment, financial history, and other factors. In hard money lending, lenders are much more focused on the collateral property than on financial details. They’ll assess its value, outstanding debts, and other factors.

How long does the underwriting process take?

Underwriting is much faster in hard money lending than in traditional lending. While underwriting in a traditional loan process can take 30-45 days, it typically takes less than 7 business days for hard money loans.

Do hard money lenders pull credit reports during underwriting?

Not usually. Hard money lenders aren’t concerned with credit score or any other financial factors. They’re primarily concerned with the collateral property.

What is a conditional approval in underwriting?

Conditional approval means that the loan may be approved once certain conditions are met, like clearing title issues or making necessary repairs to the collateral property. Once these are remedied, the loan is likely to be approved.

What is ARV in underwriting?

ARV means after repair value. This is the expected value after renovations are completed on a property. It typically applies in hard money loans for fix-and flip-properties. While some lenders consider ARV in the underwriting process, Source Capital solely looks at current market value.

Apply Now