Underwriting is a crucial part of obtaining a loan or insurance, and credit scores are an integral component. But the whole underwriting process can be a confusing and stressful experience for applicants. In this blog post, we break down the basics of underwriting and credit scores to help you better understand how lenders and insurance companies make decisions. 

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What is underwriting?

Underwriting is the process an institution goes through to decide whether or not to take on a financial risk, such as granting a loan or offering insurance coverage. The process involves gathering information about the potential customer such as their credit score, income and assets, outstanding debts, lines of credit, and property. After the underwriting process is complete, the institution either grants or denies whatever financial risk an individual has applied for (like a mortgage or insurance policy).

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What processes require underwriting?

Underwriting is primarily conducted by lenders and insurance providers when they are determining whether or not to approve a request for a loan or for something to be insured. By evaluating the applicant’s financial information, underwriters determine the level of risk it would be to grant a loan (like a mortgage or car loan) or offer an insurance policy to that individual, and either approve or deny them. The greater the risk, the less likely the applicant will be approved.

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What is a credit score?

A credit score is a number based on the information in a person’s credit report, which includes the history of how many credit accounts are currently open, closed credit accounts, history of on-time versus late payments on those credit accounts, accounts that are in collections, how many times a person has applied for credit, etc. Traditional credit scores fall in the range of 300 to 850, with anything over 700 being considered “good” and in an individual’s favor for receiving approval through the underwriting process. Historically there have been three major credit bureaus in the United States that calculate credit scores: Experian, Equifax, and TransUnion.

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How is a credit score used?

The primary use for a credit score is for loan and credit approvals. The assumption is that the  higher a person’s credit score is, the more likely they are to make on-time payments on their loans, rent, insurance policies, etc. Likewise, the lower the score is, the higher the risk is (and, presumably, the less likely an individual is to make payments). Credit scores are also used to determine a loan’s interest rate and other terms related to the loan once it has been approved. Similarly, insurance agencies can use an individual’s credit score to determine an insurance premium, or the amount an individual pays every month to stay insured. Finally, credit scores are often used in rental or lease applications.

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What info has historically been used to determine credit score?

A person’s payment history, how much that person owes on existing loans or lines of credit, the length of their credit history, what kinds of credit an individual has, and the amount of times a person’s credit score has been officially requested.

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Learn more about underwriting and cashflow here and here.

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