If you’re at all familiar with commercial credit, you’ve heard of “underwriting.” It’s a term that appears frequently in the context of commercial lending, but the meaning isn’t always clear. Before you engage your business in commercial credit activity, it’s important to understand the what, why, and how of credit underwriting.

What is credit underwriting?

Underwriting — as both a practice and a common credit term — most likely originated with marine insurance as first practiced by Lloyds of London in the late 17th century. Risktakers, aka underwriters, would literally write their names under the amount of risk they were willing to assume for a merchant voyage in return for a premium.

Today, underwriting refers to an extensive analysis of creditworthiness. Underwriting differs from a standard credit check in the amount of detailed information gathered and the depth of analysis with which the information is reviewed.

Types of underwriting

The type of underwriting depends on the type of credit to be issued. Types include:

  • For health or life insurance policies.
  • Related to stocks and/or bonds.
  • Typically mortgage loans.
  • Lines of credit. Commercial (i.e., B2B) credit extended by one business to another.

Though similar, each type of debt has specific credit underwriting practices for evaluating potential clients.

The underwriting process

Following is a simplified example of a credit underwriting process. Keep in mind that each type of credit underwriting has a different process, and every creditor has its own version of said process. In general, credit underwriting involves:

  • Creating rules. Rules should be relevant to the type of credit and include classifications, structures, and the outline of proper governance procedures to streamline the underwriting process.
  • Reviewing the application. Pay close attention to what information the potential client provides. Take note of what the loan is meant to be used for, how much the client is asking for, etc. Compare this information to the rules you’ve established and the facts supplied by an accredited credit evaluation.
  • Gathering the relevant data. What is the applicant’s credit score? Do they have an extensive borrowing history? What is their repayment history or status on previous or outstanding debt? Collect any information pertinent to risk assessment.
  • Concluding with approval, suspension, or denial. Arrive at a conclusion by filtering the data you’ve gathered on the applicant through your previously established rules.

While these guidelines are by no means exhaustive, they provide a general overview of the credit underwriting process.

The term “credit underwriting” describes the process of using data to determine creditworthiness, and it’s essential to understand the basics — and the associated risk — before engaging in commercial credit activity.

Need help managing your commercial credit risk? MSCCM financial experts can assist you. Contact us today.