What is Underwriting?

Published by Thomas Herold in Banking, Laws & Regulations, Real Estate

'Underwriting' is explained in detail and with examples in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.

Underwriting refers to a means of determining if a consumer is eligible or not for a particular kind of financial product. These products vary depending on the person’s or business’ requirements. They might include home mortgages, insurance coverage needs, business mortgages, lines of credit, or financing for venture start up projects. The bank or other financial institution undergoing the underwriting evaluation procedure will look into the odds of the business transaction successfully providing them with a profit in exchange for their offer of financial help.

As banks and insurance firms go through the underwriting process, two different things will occur. The first of these is showing an interest in the project that the borrower is proposing for finance. They demonstrate this by offering the financial aid that the customer is requesting. Next, with a bank or institution underwriting an insurance policy, residential or commercial mortgage, or venture, they are looking to make money on their investment one day in the future. They might either gather these profits at one time in the form of a lump sum at a future date or little by little in monthly payments. In these underwriting activities, compensation is expected, which is commonly paid via finance charges or other fees.

Underwriters contemplate more than simply the amount of risk that an applicant demonstrates. They also consider the potential risk that working with the new customer might bring to other customers of their company. In order to ensure that the bank or firm does not suffer too much harm to keep up with commitments made to already existing clients, they have developed underwriting standards.

Insurance companies heavily rely on underwriting in performing their business. Health insurance is one example of this. Health insurance providers seriously look into the past and present health of a person applying. Sometimes their underwriting will show that they need to exclude various pre-existing conditions for a certain amount of time when they insure the person. Other times, underwriting will reveal a medical history that demonstrates too much risk for the company. In this case, a health insurance company will refuse to provide the requested health insurance coverage. Their goal is to not insure individuals who they believe will need significant medical treatment over time, so that they can provide a solid financial backing for their existing clientele.

In business, underwriting is commonly employed to determine if new ventures should be given financing. An example of this might be a company that has created a new technology that it wishes to sell. These underwriters will consider how marketable the product appears, the applicant’s marketing plan, the expense of creating and selling the new items, and also the odds of the company realizing profits on every piece that they sell. Sometimes, underwriters of these business ventures will express an interest in having shares of stock in the start up company as a portion of their payment for services. Other times, they will only require a set interest rate for the dollar amount invested.

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The term 'Underwriting' is included in the Laws & Regulations edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.