On a very personal level, almost everyone has a basic awareness of his or her own credit worthiness. Who knows your credit history better than you, who can tell whether you are able to avail of a loan and pay it back in prescribed time along with interest, better than you? However, there is still a need for individual and business credit appraisals in the banking and financial sector. By definition, a credit appraisal is a process that involves evaluating your credit history to arrive at a decision in regards to your credit worthiness. Your borrowing and repayment patterns are analyzed, your current debt is analyzed, your credit score is analyzed; and all of this makes up the credit appraisal process. This brings us to questions pertaining to the relevance of credit appraisals; let’s explore further to know more.
Credit Appraisals and Loans
While you are aware of your credit history and your ability to avail of and pay back a loan, a bank or an NBFC does not have access to that information readily. When you approach a bank or an NBFC for a loan product on offer, the bank or NBFC needs to evaluate your eligibility for the loan and your ability to pay back the loan. As such, it is upon the bank or NBFC to conduct a credit appraisal to check your credit worthiness, after which; the bank or NBFC can decide whether to sanction the loan or not. As such, credit appraisals are intrinsically linked to the borrowing and lending transactions conducted between financial corporations and their clients.
Credit Appraisal Process – Factors for Evaluation and How it Works
While the common goal of any bank or NBFC is to evaluate the creditworthiness of a potential borrower before lending; a financial corporation is likely to have its own norms and guidelines that determine the credit appraisals process. The task set out for the bank or NBFC when approached by a potential borrower is to appraise the financial character of said borrower before sanctioning a loan, only to ensure that repayment is guaranteed on realistic terms. To conduct this financial character appraisal or credit appraisal, a bank or NBFC is likely to rely on varying financial records of an individual, including but not limited to…
- The evaluation of an individual’s credit history
- A study of borrowing and repayment patterns
- Punctuality, or lack thereof, in paying monthly installments on current and past loans
- Credit Score
- In total, the borrower’s attitude and actions in keeping with his or her debt obligation
Considering all these factors, the bank or NBFC is likely to arrive at a decision of a potential borrower’s credit worthiness. A high credit worthiness is likely to result in a loan being sanctioned or vice-versa. Additionally, the profile of an individual or business is also likely to be closely evaluated to determine credit worthiness. As such a bank or an NBFC may also take the following factors into consideration while conducting a credit appraisal…
- Ability to Repay a Loan
- Career and Occupational History
- Loan History and Current Debt
- Employment Type
- Potential Borrower’s Monthly Expenses
- Future Liabilities
- Taxation History
- Financing Records
- Ownership of Assets
It must be mentioned that a verification of a potential borrower’s credit score is intrinsic to the credit appraisals process. In most cases, a bank or an NBFC will not ignore a poor credit score and extend a loan product, unless the loan product is customized for those with poor credit scores. However, this calls for a definition of credit scoring and its relevance to the credit appraisals process.
What is Credit Score?
In simple parlance a credit score is a numerical value indicating an individual’s credit worthiness, based on past credit history and present debt.
How the Process Works?
The actual calculation conducted to arrive at a near to accurate credit appraisal, takes into consideration all of the factors above, and determines the borrowers…
- Fixed Obligation to Income Ratio – An evaluation of loan repayment obligations every month, compared with monthly expenses and income generated every month.
- Installment to Income Ratio – A direct evaluation of income per month in comparison to monthly EMIs that will be paid by a potential borrower, once the loan is sanctioned and disbursed.
- Loan to Cost Ratio – If the loan product is intended to finance a purchase, such as a car or a home, an evaluation of the cost of intended purchase is conducted, based on which the bank or NBFC defines the lending amount, be it 70% or 90% of total cost.
In conclusion, the credit appraisals process is the most trusted procedure for financial corporations to ensure loan repayments.