What are the steps in the loan origination process?

Loan origination process is a process in which a bank or a lender takes information from individuals or small businesses owners and makes a decision to extend credit. Banks and financial services companies generate revenue by lending money to consumers or commercial clients with an interest and sometimes a fee.

The loan origination process takes three steps.  

Step 1 - Advertising and marketing

First, banks and lenders need to let people know that they offer credit products and services for individuals and small businesses owners. They can advertise through traditional media such as radio, television and newspapers advertisements. These advertisements often contains information such as the maximum loan amount, minimum interest rate and duration of the payback period. 

Some banks offer credit cards and their advertisements would often consist of maximum credit line approved amount, balance transfer fees, minimum monthly payments, interest rate and reward point structures.

Banks and financial institutions sometimes use direct marketing techniques. One of the most popular channels of direct marketing is “direct mail”. Direct marketing using mail has been around for decades. 

Banks work with credit bureaus to extract information from millions of consumer financial records. They then analyze these records and detect any need for credit from millions of these consumers. Banks might look at the individual's credit score, number of credit cards or loans they may already have and how well these consumers have been keeping track of their repayments.

If these individuals have a track record of on time payments, and they haven’t maxed out their credit card balance and make a decent living and still have a little bit of additional income left to borrow more money, banks will then pick this individual and send them a piece of mail advertising their loans or credit cards.

We all have received these mailers in our mailboxes before. These mailers consist of a single letter letting us know that we have been prequalified or preapproved for a financial product, often in the form of a credit card.

There might be a special code for us to enter into a website or call into a toll free number to accept the loan. Additional questions might be asked of us when we enter these websites or get on the phone with the banker and sometimes we might get declined because of lack of proof of income or deteriorated credit history, e.g. recently missed payments.

Social media advertising is another place where financial services can find individuals and companies to advertise their loans to as well. Although social media platforms have a strict rule on the type of financial products being offered. Often, they discourage predatory or high interest rate bearing products that might harm the consumers.

Search engines are also a good place where banks find their potential clients. Billions of people use search engines to find just about everything and a good amount of folks are trying to find credit cards, loans, mortgages, auto loans, student loans. When the research results come back, advertisers can overwhelm the first page of the research result and advertise their credit card, auto loan, mortgage products.

There is a new breed of companies called price comparison companies that aggregates all of the banks and financial services offerings. They are basically a very specific breed of search engine focused only on financial services and their products. A potential individual looking for loans and credit cards will enter their limited information and these price comparison companies will send this information to hundreds of bank partners and seek approval.

Most of the banks nowadays have real time decisions and offer engines inside of their four walls and can return their approval or decline decisions within real time. These aggregators will then display these approvals back to the consumers for them to take their pick and follow through with the rest of their onboarding process. 

This leads us to the second step of a loan origination process.

Step 2 - Identity verification and underwriting

Whether the banks get their lead from their branches or online landing pages, all of the applicants will need to go through an underwriting process. This process consists of three elements. 

First element is a positive verification of a person’s identity. Whether they are applying for a personal credit card or the small business owner is applying for working capital. The person who’s signing the agreement has to be cleared from an identity verification underwriting process. 

Sometimes the banks will use third party identity verification databases to triangulate whatever data that’s been presented through an application form. Sometimes the bank will ask the applicant to upload identity verification documents such as driver licenses, or passports where the applicant’s photo appears.

These identity documents are then scanned in real time and the information on these identification documents will be compared to what’s supplied by the applicant. Lately, the bank will ask the applicant to also take a selfie through their computing devices such as mobile phone and use the selfie data to compare to the photo from the identification document. 

There are banks still using out of wallet questions to verify applicants. These out of wallet questions or knowledge based authentication products will prompt your last mailing addresses or cars you may have owned in the past to verify that you are who you say you are.

Regardless of the identity verification method, banks and financial services companies must positively verify the applicant’s identity before moving onto the next element of their underwriting process.

The second element in the underwriting process is detecting creditworthiness. There are two ways to go about doing this. First, the bank will review the individual’s credit report. Credit reports are composed by credit bureaus. 

These credit reports consist of a person’s credit history. How many credit products does this person have, how long have they had these credit products. Most importantly, has this applicant have always made on time payments to their credit obligations or are there any missed payments from time to time?

These credit reports also track employment history and previous addresses a person has lived at. If a person declared bankruptcy, these credit reports also carry this type of information as well as tax liens. Although some of the tax lien records are now not allowed to appear in credit reports.

Bank will take all of this aforementioned credit reporting history and make a comprehensive decision. Before automated decision engines and credit decision engines, bankers have to read these credit reports and make a decision manually. This manual underwriting process is neither consistent nor scalable. 

Automated decision engine tools are now the dominant ways to consistently underwrite applicants in real time by having software digest credit bureau reports. These credit decision engines can calculate scores, run complex decision processes in a fraction of a second and return results back to the consumers or price comparison websites quickly.

The last element in any loan origination process is income verification. Banks often ask applicants to submit their income verification documents such as W2, 1099, tax filings or financial statements for further verification.

There are a myriad of tools that can scan these documents in real time or semi-real time for any credit decision engine to continue their underwriting process. There are also other tools that can scan through complex tax filing and financial statements and create a summary for decision engines to render a decision.

In recent years, Open Banking software has been flooding the market. These widgets fits nicely into the loan origination process. This software lets users log into their bank account and payroll systems using their bank and payroll logins.

These platforms then transform banking transactions into summarized income variables for decision engines to consumers in real time. Other payroll login systems will summarize the person’s payroll data and infer their monthly or annual income. These systems are getting ever more popular and banks rely on these tools to gain the most precise read into the applicant’s income and cash flow situation.

In some cases when the bank is lending to small businesses based on their future receivables, there are also tools that let the small business owners log into their account receivable platforms and return a summarized future income scenario for underwriting. 

After identity, credit history and income information have been verified. The loan origination process will initiate an offer engine to offer the right products to the applicant. This could be a credit card, loan of any kind. These offer engines will take credit history and income, cash flow into consideration and offer the right product that the applicant can afford and willing to accept.

The credit offer engine is tied at the hip with the credit decision engine. There could be multiple products being offered to an applicant such as a checking account and a credit card. Within each product, there could be a variety of flavors of the same product being offered. Such as a credit card with various reward features. Or if its a loan product, there could be varying types of loans that have different repayment periods etc.

Step 3 - Loan servicing

After step 2, the underwriting step has been completed, the bank will send this approved application to a servicer. 

A loan servicer performs a variety of functions. One of which is the disbursement of the funds. If the applicant has been approved for a $20,000 personal loan, the servicers will send these funds to the applicant’s check account.

Sometimes these funds arrive on the same day, sometimes these funds might take a few days to appear in the applicant’s checking account. If the bank is issuing an auto loan, the funds will be sent to the car manufacturer or their dealerships directly. 

If the money is used to purchase real estate, such as a primary residence, the funds will be sent to the escrow company to complete the rest of the transaction.

The other main function of a loan servicer is the ability to collect the installment payments from the applicant to repay the loan within the term of the loan. For example, if you took out a car loan and the loan period is 60 months. Every month, the loan servicer will deduct the monthly repayment amount from the applicant’s bank account until the loan is paid off.

There are other functions such as the ability to pay off the loan before the loan term is finished or modify the loan characteristics if the applicant experiences hardship during the loan repayment period. 

These are just some of the activities that will take place immediately after the loan origination process is completed. Keep in mind that most of the banks originate their loans under their brand but the loan servers operate under a completely different brand.

The loan servicers will send a letter to the applicants letting them know that their loans are now going to be taken care of by the loan servicer as opposed to the bank that they took out the loans from. Banks could also sell these loans in bulk in a secondary market to funds which will identify their own servicing company to take over the loan servicing aspects of the loan post originations.

Loan origination tools

Loan originations nowadays rely heavily on technology to automate and scale. Consumers are also expecting an instantaneous credit decision as well.

The banking technology industry has matured with cloud technology, availability of third party data. Optical Character Recognition (OCR) and facial scan technology are available anywhere now to speed up the identification and verification processes.

A robust decision engine is needed to collect and process application data, third party data, scanned information and return decisions in seconds to remain competitive. Banks and Fintechs are constantly reinventing themselves to come up with creative ways to onboard clients as quickly as possible.

We can’t wait to see what the future holds in advancing loan originations process technology.