Commercial real estate is a wise investment, but investors will likely need to take out loans to acquire commercial real estate assets. Taking out a loan is a multi-stage process, one of the most prominent being underwriting.
Understanding key processes in the acquisition of loans, like underwriting, help investors know what to expect and effectively plan ahead for a better experience. Explore this quick guide to understanding commercial real estate underwriting so that you can have a seamless experience when you take out your loan.
What Is Underwriting?
Underwriting refers to a financial verification process carried out by a lender on the prospective borrower. Issuing a loan empowers investors to make life-changing financial decisions, but taking on a loan is a big decision. Therefore, lenders must remain cautious about how they are issued.
Underwriting is a screening process undertaken by lenders to properly assess a borrower’s qualifications for loan approval and to set appropriate parameters for the loan; lenders use underwriting to protect themselves and to connect borrowers with loans most amenable to their financial situation.
Underwriting takes into account many financial factors that affect the acquisition of high-value assets like commercial property. By accounting for these myriad factors, lenders get a complete perspective on a borrower’s likelihood to effectively utilize their loan and to set interest rates that borrower’s can be expected to pay off.
What Happens During Underwriting?
Underwriting happens on the backend of loan approval. Borrowers take no part in the actual underwriting process. Underwriters may ask borrowers to produce financial information that helps them assess their financial capability.
The underwriter works with the mortgage lender to assess borrower qualifications based on the information they provide. Underwriters may reach out to you directly to acquire the requisite paperwork they need to make this assessment. When they draw their conclusions, the underwriter will report to the mortgage lender with their final assessment on whether borrowers qualify for the loan.
An underwriter may examine any number of financial indicators in a borrower’s history in addition to financial information about the property in question. Here are a few actions an underwriter may take over the course of the underwriting process:
- Assess credit history
- Conduct a property appraisal
- Establish income history and employment status
- Determine debt-to-income ratio (DTI)
- Examine savings account and down payment capability
What Information Should Borrowers Have Ready?
Underwriters are the primary agent making the decision for approval or denial. To ensure that the underwriting process happens as seamlessly as possible, borrowers should have a firm grasp on the information underwriters will expect to see.
Here are the key areas underwriters will examine before they make a decision on a borrower’s qualifications for approval:
- Credit Score
- Income Information
- Owned Assets
A borrower’s credit score has a profound impact on whether they are approved. Credit scores are a measure of an individual’s financial reliability. Credit scores measure an individual’s credit behavior, showing whether they pay off their creditors on time, how many loans they take out, and more. Few metrics provide the detailed financial information provided by credit score.
Credit scores are qualified by five hierarchical ranks: poor, fair, good, very good, and excellent. Typically, credit scores range from 300 to 850. The higher the score, the more likely prospective borrowers will be approved for loans.
Building a strong credit score is a fundamental part of loan approval. Strong credit scores indicate borrowers possess the fiscal responsibility to effectively use their credit. It’s the clearest way to establish trust with a lender and gain approval for better loans.
Underwriters will need to see a borrower’s income reports before they make the final approval for a loan. A borrower’s income level establishes their financial capability to pay off their loans in due time; the borrower’s total income streams constitute the lender’s income stream to pay off their issued loan and accumulate interest.
Because commercial real estate is so expensive, underwriters issuing commercial real estate loans may require detailed information about a borrower’s income status. Borrowers may be required to produce their annual income report not just for the past year but also for expected income for the coming year.
The more income information borrower’s can provide, the better their likelihood of loan approval. Income history over a three-year, five-year, or even ten-year period gives underwriters a detailed perspective on the borrower’s income status and their ability to pay off their loan.
Property appraisals are essential to the underwriting process because they provide crucial information about the value of the property. A property appraisal is a detailed evaluation of the property asset’s total monetary value.
While appraisals are an essential part of the underwriting process, it is typically incumbent upon the party acquiring the property—the borrower—to schedule an appraisal of the property on their own.
An appraiser will examine any number of property attributes to assess its value: its size, the condition of the property, distinctive features of the property, and value comparisons of similar property types (comps).
The appraiser’s assessment of the property value is, in turn, submitted to the underwriter. The underwriter will compare the value of the property with the value of the mortgage. How these values compare informs the underwriter’s approval of the loan. If the property is valued much lower than the mortgage, they may suspend the issuance of the loan.
Underwriters may ask to examine a borrower’s owned assets in addition to their income. In the event that borrowers default on their payments, liquidating their owned assets can provide the income to continue paying off their loans; they are another potential source of income borrowers can rely on to continue with their loan payments.
The more value borrowers have from owned assets, the more confidence underwriters will have in their financial ability to keep up with their loan payments. Additionally, borrowers may be able to use their assets as collateral for their loans.
How Long Does Underwriting Last?
The duration of the underwriting process will vary depending on a case-by-case basis.
A number of factors inform how long borrowers should expect to wait before the underwriter makes their final assessment on their loan approval, including the size of the loan, the amount of information the underwriter requires, and how quickly the borrower is able to get their financial information to the underwriter.
To facilitate the underwriting process, borrowers are advised to work with the underwriter closely to ensure they have everything they need to conduct their assessment.
Finances are a private matter. However, being as transparent as possible with your underwriter will help you speed up the loan approval process and build the trust that can help you get approved for your loan.
What Is a Typical Real Estate Loan?
Knowing the process behind underwriting helps borrowers get ahead for a better chance of loan approval. For investors interested in taking out a commercial real estate loan, it’s important to have a general idea of how much they should expect to take out. That way, they’ll know what to expect when they go through the underwriting process for the loan.
The size of the loan may vary depending on the type of loan the borrower seeks out. There are a number of financial outlets investors can turn to for high-value, commercial real estate loans. The average for a commercial real estate loan from a traditional bank is as follows:
- Loan amount: Upwards of one million dollars.
- Loan rates: Between five and seven percent
- Max term: Typically 10 years
- LTV ratio: 80 percent
The Bottom Line: Be Ready for the Underwriting Process When You Take out Your Commercial Real Estate Loan
Commercial real estate loans are massive. Gaining approval for commercial real estate loans puts the due diligence on borrowers to have all they need on their end ready for the underwriting process when they arrive at that stage. The first step towards loan approval is choosing the right loan in the first place and finding the lender best suited to your financial needs.