Most people have a good feeling what is wrong when they get declined for a loan. But it can be a total shock if you get refused a loan when you have always been a good boy in terms of debt payments. You pay you credit card bills in full in a timely manner each month like what the experts recommend, yet be turned away from borrowing. And it can be a real nightmare when you need the funds to buy important stuff like the small matter of a house.
So what criteria do lenders use to determine your borrow-worthiness? Generally, these are the 5 areas.
1) Income
The amount of money you bring back is a big determining factor of the size of the loan you can get. Your eligible loan quantum scales up accordingly as your income rise. You can’t really expect to obtain a million dollar loan if you have a $1,000 salary right? Income levels of more parties can be taken into account when the loan you are applying for concerns more people.
For example, when you are buying a house, the total household income can be used when assessing the income level. This is because your spouse or other third parties become borrowers as well. This is the same when third party guarantors are involved. Common scenarios where third party incomes are taken into consideration are study loans and auto loans. Remember that niece who need you to do her a favor by being a guarantor for her education loan? Those are the types of situations that I’m referring to.
Many people actually get their credit scores pulverized by being third party guarantors. This is due to the borrower making late payments or even worse, default on their debt. in this case, because you are a guarantor, you will clock in the default as well in your credit history. So just make sure that when you become a third party guarantor, play your role by ensuring the borrower repays.
There are instances when you will be able to pass the lender’s assessment criteria even when you have little to no income. This leads to the next criteria.
2) Assets
Your assets reveal your capacity or capital. The higher they are, the safer banks will feel about lending to you. The logic is that if you fail to pay up, the lender can seek redress by seizing your assets and liquidate them to settle whatever is outstanding. It is not uncommon for mortgage lenders to approve the maximum loan-to-value you can get when you display properly documented assets worth a certain value. This practice is called asset-based lending.
Sometimes, mortgage lenders can even approve a mortgage just from verifying your assets without ever looking up your income status. That’s how much they like to see assets.
Lenders are also known to loosen their assessment criteria when you put up a down payment higher than the norm. For example, when home buyers frequently pay a 20% down payment for a property, you will impress any borrower when you put up 50%. It is a show of financial strength. And more importantly, a display that you are someone who does not overleverage and is more than willing to play it safe when it comes to finances.
The act of laying down more capital presses all the right buttons.
3) Collateral
Loans and credit facilities are more easily obtained when there is collateral involved. This doesn’t need a lot of explaining as lenders will feel that they are taking on lesser risks when there are assets that can be sold or auctioned off to repay what is owed. You will be able to see the level of risk lenders tag to such credit facilities from the lower interest rate they charge for them.
Hire purchases, trade facilities, and auto loans are some of the most common types of secured lending. The key here is that the security has a certain value. For example, you cannot expect to get a $100,000 loan when the machinery is worth $90,000. Professional valuers are often used to appraise the value of the assets. However, in many instances, just the quotation or sales order for a machine would be enough to judge value.
The problem with relying on sales orders, receipts and quotations is the potential of fraud.
4) Experience
This is an intangible factor that judges your ability and character. This can be critical on how well you are going to keep yourself afloat. Experience is a very big factor when it comes to small business loans. A company can be 2 weeks old, but if the key Director has years of directorial experience with successful companies, the tide can turn in the borrower’s favor.
It can really help if a borrower has a profile higher than the average person in a good way.
5) Credit
It is a well known fact that a lot of lenders would turn down a borrower if he has bad credit no matter how much he makes a year. Good credit can provide you with a lot of advantages, and bad credit can potentially destroy you.
As the only way a lender can judge how good a borrower you are is from your credit history, you cannot blame them for turning down customers with bad credit. If someone has already proven that he is a naughty paymaster, it would be crazy for a bank to look the other way. Banks are known to err on the side of caution anyway.
You can check your own credit record by purchasing them from the credit bureaus. If you have not run into any huge financial catastrophes, you should be able to improve your credit score in the long run as long as you start repaying your bills on time.
When you apply for a credit facility or a loan, your most recent payment records are more closely scrutinized. So a recent overdue payment that is the cause of your rejection can be a non-issue if you wait it out.
For example, if assessment for an unsecured loan takes into account your recent 6 month payment history, you will be safe when you hit the seventh month. The problem is that you have no idea what are the standards lenders use for different products.