Whenever we apply for a loan, the application is assessed to determine the applicant’s creditworthiness. Similarly, credit card applications and the request to increase the credit limit also go through an assessment to help financial institutions and lenders make a decision. This process of evaluation is called credit appraisal.
How do lending institutions decide whether to accept or reject the borrower’s application? What are the eligibility criteria for credit appraisal? What are the steps involved in a credit appraisal process? We have answered these and other important questions in this detailed guide. Let’s read.
What is Credit Appraisal?
Credit appraisal is an evaluation process where a potential borrower’s financial capacity is assessed before approving their loan application or increasing their credit limit. It involves analysing credit history and other financial data to gauge the applicant’s creditworthiness and ability to repay.
Lenders may use different techniques in the procedure of credit appraisal based on certain rules, norms, and standards. The evaluation process also determines the credit/loan structure, including the interest rate, based on lending rules.
Eligibility for Credit Appraisal
Different lending institutions usually have their own eligibility criteria. However, here are some common elements in the credit approval process –
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Income Stability
The credit appraisal eligibility is influenced by your income level, work history, and overall financial status. The lender gathers applicants’ information to understand how likely a potential borrower is to make timely repayments.
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Credit History
Financial organisations also use your credit history when evaluating your loan or credit card application because it reflects the borrower’s repayment track record. A person’s sound financial standing is shown by their credit history.
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Loan-to-Cost Ratio
This measure assesses the relationship between the loan amount and the cost associated with the fund’s intended use. This is crucial in precisely calculating the loan or credit amount eligible for authorisation.
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Debt-to-Income Ratio
This ratio assesses how much of a borrower’s income goes toward existing debt. A lower debt-to-income ratio indicates a smaller debt, which increases their eligibility for credit appraisal.
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Collateral
Lenders assess the amount or value of collateral submitted by borrowers seeking secured loans as part of the credit assessment process before making a final decision. Collateral may be financial or physical, for example, a home, business, jewellery, land, machinery, or other similar assets.
The Credit Appraisal Process
Here are the steps to assess the creditworthiness of individuals in the credit appraisal process –
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Application Review
The first step is the application review where a preliminary screening is done to check if the application meets the basic criteria like income and age. The financial institutions carefully examine and verify all the information provided in the form, which is why it is critical to fill in details accurately and avoid errors.
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Documentation
Post application review, personal and financial documents, such as proof of identification, bank statements, and address details among others, are verified. To save yourself trouble, submit the application together with the necessary supporting documents.
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Finance and Risk Assessment
The bank or lender examines the repayment history of the applicant or potential borrower. The lender may assess present debt (if any) and other financial data to get an understanding of the borrower’s financial status and credit risk. This step is crucial in deciding whether the applicant is eligible for credit and also helps banks assess the risk of lending.
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Loan Structuring
Once the applicant clears financial evaluation and risk evaluation, the lender decides on loan terms, which include the principal amount, interest rate, and repayment schedule.
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Approval and Administration
The lender finally approves the loan once all conditions are met and procedures are completed. However, how long it takes for the reimbursement or credit appraisal to complete depends on the lender and the appraisal amount.
Additional Parameters Involved in the Procedure of Credit Appraisal
Here are some additional parameters that help decide whether or not a credit appraisal request will be approved –
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A
Industry and Market Analysis
Market and industry research is helpful for the purpose of ascertaining if the applicant can generate sufficient cash flow and make timely loan repayment.
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B
Bankability
It is generally an important factor to take into account as it refers to the appraisal amount the lender will permit. It involves understanding if lending money to a certain person or business will contribute to profits and cash flow.
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C
Business Plan
Startups and growing businesses must have a thorough business plan that details their strategy, market study, financial projections, payback timetable. These variables may vary based on individual requirements.
Benefits of Credit Appraisal
The primary advantages of the evaluation process are as follows –
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Risk Analysis
The procedure of credit appraisal assists financial institutions in reducing loan risk. It helps make wise decisions and guarantees the security of money provided as credit.
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Determining Loan Amount
It gives lenders the freedom to choose appropriate loan conditions that fit their policies and lending rules.
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Confidence Among Banks
The credit appraisal process improves openness and accountability. By establishing assurance among bankers, it can make way for other effective financial opportunities.
