Underwriting is a principle used by individuals and institutions to determine their ability to take on financial risk. In its most simple terms, the institution is determining if the reward of the investment outweighs the risk from lending money.
Companies will conduct research and study data to understand what characteristics about an individual tend to equate to higher profitability. This also goes for characteristics which correlate to a borrower who does not pay back the money they borrowed. When an individual applies for a loan, the company often will use what is called a credit score, a number on a scale that is used to determine the risk of the applicant. Historically, many institutions rely on the FICO®️ credit score. Other loan companies do not use a FICO®️ credit check when determining risk on a loan. Other means, known as Alternative Credit Data, are used in these situations to help determine the risk level of the applicant for a loan.
As a general rule for whatever methods are used in underwriting a customer for a loan, a loan applicant which is determined to be a smaller risk will generally have much better loan terms. This type of borrower may qualify for a larger loan with smaller fees and a lower interest rate.
The reverse is also true. An applicant who is determined to be a risky customer will be offered a smaller loan amount with higher interest rates and fees.
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