Consumer Loan Demand: 5 Important Criteria for Banks
5 criteria in order of importance banks are evaluating when lending a consumer loan
There are many criteria banks and other financial institutions are looking at when someone applies for a consumer loan in order to accept, refuse or accept "with condition" the demand. Here is the list of 5 criteria, in order of importance, which banks base their decisions on for consumer loans:
The personal credit, such as the beacon FICO scores, is the number one criteria by importance. The personal credit is the payment habit of the consumer with their past and current creditors. The report represents, to the company lender, a projection of the applicant's behaviour on their future loan.
“History is bunk” Henry Ford would say, but those who proved to be good payers to their old lenders will have better chances of being accepted for new loans. On the other side, applicants with bad credit that include collections, severe late payments or bankruptcies will have their files dismissed from further evaluation; these types of applicants often mean future problems for banks.
This is the time an individual takes to be established in society.
Time at their job
The first aspect of stability is the time at their job. The longer the time someone spends at their current job, the stronger they will be settled professionally and the lower their chances of becoming unemployed. In the world of credit, employment guarantees income, the main source for debt payment. The loss of a job often leads to problem executing payments and increases the risk of defaulting. Regular payments made on time are more assured when a person has job stability.
Time at present address
The time at present address is one of the most neglected and unknown aspect by applicants. However, many statistics and analysis showed that someone who has lived only for a short period of time at their current address has more chances of moving away and leave their debt behind. On the other hand, having lived at the same address for a long time improves the chances of obtaining credit. This is weighted considerably in the final decision.
Homeowner / Tenant
The status of homeowner and tenant plays a definite role in stability. For obvious reasons, a homeowner has more responsibilities and their risk of moving away is smaller, as opposed to tenants, known to be less predictable. Being a homeowner is a positive in term of stability.
The debt ratio is the ratio between monthly payments of the debt, including the new loan, and monthly gross income. The limit of an acceptable debt ratio differs from banks to banks and the type of credit requested, but normally ranges between 35% and 50%. The level of acceptability also depends on the first two criteria (personal credit and stability), but a debt ratio too high can stop a loan from being accepted, no matter how good the credit or stable the applicant is.
The net value is the financial equity of an individual, which is the personal asset minus the personal debt. The assets taken in consideration by banks are the verified real estate market value of their home and a portion of personal investments, where 50% to 80% of their value is considered based on risk level. On very rare occasions cars and other vehicles are considered assets, as they constantly devaluate.
The biggest asset is normally the real estate. However, these assets are the least liquid; selling the house to pay some debt is really the last resort. Therefore, a decision cannot be based on the net value before the first three criteria. It is more of an indicator of how deep pocketed the applicant is.
If the person has a good equity on their property, it will weight considerably in the credit application. Not necessarily because the property can be included as a guarantee, but great equity always gives someone the possibility of obtaining additional indebtedness on the mortgage, which will help face financial obligations.
Occupation and Personal Status
The occupation is taken into consideration in a credit application. Doctors, lawyers, engineers and other professionals will be more valued than self employed workers, the nature of their work being more unpredictable, and blue collar workers, because it is more difficult to turnaround in case of job loss.
The age of the applicant is the main issue, even though it is considered discriminatory, the lenders will still take it into consideration. The chances of default are much higher under 30 years old than 50 years old and up, considered the most desirable age bracket. Less than 20 years old is the highest risk.
These points determine the interest rate and the goods that will be taken as collateral. In the case of personal loan, line of credit or other loan where the decision is based only on the individual applicant, the rate or the guarantee will fluctuate based on the answer given in the first five criteria. In the case of credit cards, these criteria will not be as important since the interest rate is already high, reducing some risk of monetary loss for banks. The same principle applies on a mortgage or the financing of a vehicle, where collateral can lower the acceptance barrier.
In general, banks are looking for a consistency of payments on the debt, therefore a guarantee of a good cash flow towards them. The lesser importance of the other criteria reflects a less immediate guarantee of payment. If we interpret their analysis based on the cash flow, banks are first looking at the reliability of the payer, next at the regularity of their payments, their payment capacity, and finally, the bank's capability to get their missing payments in case of default. If one criteria is not positively fulfilled, the next, lesser important one will not be taken into consideration.