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How Does a Loan Work?

Learn More About the Loan Process

Ever wondered how a bank loan really works? Besides the application and closing process that you are typically involved in, there is actually a lot of thought, analysis and work that go into the process "behind the scenes".

While it's easy to feel like a bank is making their lending decision personal to you, its actually really all about spreading the risk. Specifically, here is how the whole loan process works.

Choosing a Loan Type

There are dozens of types of loans available. They depend on what is being financed. For example, there are home loans, boat loans, car loans, camper loans and business loans. And in each loan category there are also various types of loans. For example, if you are financing a home, there are new home purchases, refinance loans, home equity loans, fixed rate loans, adjustable rate loans and even balloon payment loans. The types of loans are nearly endless but the loan process should always start with researching the loan that best suits your needs.

Loan Application

The application process includes filling out information about your financial position. It includes your assets, as well as your liabilities, or what you currently owe others. It also includes your cash flow analysis, which is what you earn in income minus the monthly expenses that you are required to make. After you complete your application the lender sends your information to "underwriting".

Loan Underwriting

During the underwriting process, the loan application information is analyzed by one or more individuals assigned to that loan. They look at ratios, risk levels, debt burdens and literally hundreds of different risk factors to see if they can approve the loan. An appraisal is ordered to seek a third party's opinion.

 Underwriting is more or less a due diligence process where the lender tries to uncover any risks that would make the loan a bad investment. At this point, they also check to see if the loan conforms to all of the underwriting standards imposed by the lending agencies. If it does, the loan is approved and the next step is to work toward closing the loan.

Loan Closing Process

The closing process is not overly complicated, but it is usually pretty time consuming. That's because it takes dozens of people coordinating information to check off all of the due diligence items before the loan can fund. A title company will need to make sure the title is clear. An appraiser will need to verify the property being financed is worth what the loan says, and the lender needs to verify things such as flood zones, proper insurance coverage, property tax payments, and several other items.

When everything has been approved the loan is scheduled for closing. At closing, a representative from the lender and a closing agent (often from a title company) meet with the borrower and sign all the documents. Typically, the loan funds a few days later.

While the overall loan process seems rather simple to the borrower, there are lots of analysis, calculations and state, local and federal laws that must be adhered to, documented, and recorded in order for the process to be successful.