Mortgage Underwriting Standards

Underwriting standards are guidelines established to ensure that loans are issued and maintained safe and secure. In real estate, underwritings are used to evaluate and determine the viability of investments (Malpezzi, 2017). The evaluation includes doing a review of the due diligence materials that relate to the investment in order to assess the factors that may contribute to either success or failure of the investment. Underwritings processes that are thorough ensure that individual investors get quality real estate investments. Poorly processed underwriting may lead to substantial losses. The performance of already processed underwriting to a large extent determines the quality of investments.

With underwriting standards, the underwriter conducts research to ensure that borrowers of funds for real estate have represented themselves truthfully. This way, real estate companies can get the sense of the applicant’s finances and also determines whether the sale price of property is congruent to the appraised value. Underwriting processes also ensure the determination of the borrower’s creditworthiness (Zingales, 2015). Thus, the potential borrower is rated depending go their ability to pay back the funds. Before funds are given to the borrowers, they are usually required to present an appraisal. Underwriters would then use the appraised value to determine if the sales that would be generated from the real estate will sufficiently cover the amount lent. In other terms, underwriting ensures analysis of information and determining the risk involved in the transactions which directly influences the size of a loan that can be offered. Underwriting has power to approve of loans so that individuals that have poor credit history may be charged higher interests or required to pay higher down payment.

Mortgage underwriting standards prior the real estate boom and real estate collapse

The real estate boom, otherwise known as the real estate bubble happened between 2001 and 2006 before the financial crisis. Mortgage underwriting contributed to the real estate bubble and eventually, real estate collapse. Prior to the real estate boom, the mortgage underwriters eased their guidelines (Malpezzi, 2017). At the same time, interest rates and delinquency dropped. As a result, there was an increase in the prices of homes. Homeowners were forced to work for longer hours while others were forced to forfeit other consumption needs so as to ensure payment of their mortgages in time. The underwriters made riskier loans as they did ease their guidelines making loans available even to individuals that could not afford to repay the loans.

In response to the boom, real estate institutions combined mortgages into huge pools and used them as instruments to back complicated financial instruments. Unfortunately, the individuals that participated in combining the mortgages did not consider the strict requirement of underwriting standards. The rating agencies and huge real estate companies did not grasp the risk involved with their measures. Easing the underwriting standards increased the prices of houses highly, but the Americans still bought mortgages (Aoki & Nikolov, 2015). There was a continuous increase in prices and easy access to loans. The real estate market then crushed with housing prices falling after Fed’s intervention. The country’s interest rates increased and mortgages across the country soared.

Change to mortgage underwriting standards after the real estate collapse

Prior the collapse, it was thought that easy standards would make homes more affordable to homeowners (Zingales, 2015). Unfortunately, easing underwriting standards proved quite the opposite. Easy standards destroyed the demand and supply of houses; therefore, there was a need to change the underwriting standards so as to make the market less prone to boom-and-bust cycles. After the crisis, financial institutions become more discerning and scrutinized the finances of borrowers more closely before deciding whether to offer a mortgage or not. The Dodd-Frank Act codified sound underwriting rules the required lenders to make loans only after confirming that the borrower was capable of repaying the load (Ash, 2017). The confirmation was made based on the financial capacity and financial history.

Additionally, there was a new level of transparency that provided the borrower with clear ideas of what they were obligated once they take the mortgage. For instance, there was the establishment of Consumer Financial Protection Bureau (CFPB) that facilitated consumers to gain complete information before they made decisions to buy a house (Ash, 2017). Additionally, consumers were given clear information on the conditions needed to acquire credit. As such, consumers were better placed at making more informed decisions.

Give an example of the current underwriting standard for any underwriting group

An example of current underwritings is the insurance underwriting by Professional Underwriting Group, Inc. The underwriters usually evaluate the risks that are involved with potential clients. The ratings are then used to determine the amount of coverage that the client are entitled to and how much they need to pay. It involves measuring the risks that customers are exposed to and then determining a premium that would be charged.

References

Aoki, K., & Nikolov, K. (2015). Bubbles, banks and financial stability. Journal of Monetary Economics, 74, 33-51.

Ash, A. L. (2017). It's Your Money and We Want It Now: Regulation of the Structured Settlement Factoring Industry in the Era of Dodd-Frank and the Consumer Financial Protection Bureau. Miss. LJ, 86, 151.

Malpezzi, S. (2017). Residential real estate in the US financial crisis, the Great Recession, and their aftermath. Jing Ji Lun Wen Cong Kan, 45(1), 5-56.

Zingales, L. (2015). Presidential address: Does finance benefit society?. The Journal of Finance, 70(4), 1327-1363.