All finance approval is based on risk, and understanding how lenders assess your loan application can often be the difference between an approved or declined application.
If you are approved for your loan, understanding how lenders view your application and financial history can ensure you appear as low-risk as possible, which often equates to lower rates and repayments.
Before we dive in, it’s also important to understand that lenders use advanced financial technology to assess their loan applicants; you can’t fake being low-risk, but you can take steps to both improve your financial position and application before submitting it to a lender.
Let’s get started.
First, lenders will assess the application against their Knockout Rules. There are standard knockouts rules for most lenders, including:
However, each lender will also have their own unique knockout rules, which can include:
Lenders will then look at your intended legal use of the funds. While this isn’t the same as determining legality, it’s still an important aspect in determining risk.
There are two reasons for this, which reflect the assessment process:
Should you be approved for the loan, the type of loan and use of funds can affect other aspects of your application, such as how the lender chooses to apply interest rates.
When choosing the right loan for the right situation, low-risk lending will have lower fees and lower interest rates (which means you’ll pay less overall), while high-risk lending will have higher fees and higher interest rates (which means you’ll pay more than you might need to).
|Reason For Getting A Loan||Most Commonly Used Loan|
Various Use And No Collateral
Unsecured Personal Loan
Various Use And Existing Collateral
Secured Personal Loan
Various Use And Purchasing Vehicle
Secured Personal Loan
Buying A Personal Vehicle
Buying A Business Vehicle
Chattel Mortgage or Equipment Finance
Consolidating Debt Without Collateral
Unsecured Personal Loan
Fixed Loan Amount
Secured or Unsecured Personal Loan
Adjustable Funds As Needed
Line of Credit or Overdraft
In a financial context, servicing is defined by your ability to repay the interest on a debt.
At this point of the loan application process, lenders will assess your ability to meet your repayments - though most applicants misunderstand how this is determined.
Servicing is, essentially, a deep-dive into an individual’s risk level, and aspects of servicing (such as the length of time you want to borrow the money for) relate directly to interest rates, repayments, and the overall cost of your loan.
Much of this relates to the famed ‘Five Cs of Credit’ which we’ll cover below, but here’s a quick napkin example of how to understand servicing assessments:
This is how most applicants view their personal assessment - can they afford the repayments that day.
While these are four small examples, they illustrate the very clear difference between applicants and how lenders can apply risk to an individual in terms of probability:
Based on the information above, it’s far more likely that John could lose his job, take on an unmanageable amount of debt, return to unemployment, or risk missing payments beyond 12 months.
Collateral is any valuable asset you can offer as security on the loan. This means that, should you miss payments or fail to repay your loan, your lender may take ownership of these assets to sell on and reclaim their losses.
Even if you are perfectly capable of repaying the loan amount very comfortably, offering security is often one of the simplest ways to drastically reduce the interest rate on your personal loan.
Capital is your personal assets and their value. This can be savings accounts, personal objects, or anything that isn’t offered as security on the loan but shows a lender that, should things go wrong, you have the ability to sell on your own goods and cover their losses without the lender needing to repossess them first.
Assessing character can be reasonably broad, but generally this will cover your personal spending, your habitual spending, how you manage your money, your credit rating, and the consistency you present with your finances.
For example, a borrower who habitually withdraws all of their pay the day they are paid may appear to a lender to be financially unstable, unable to manage their money, and less likely to repay their loan in full. Where online lenders will use your bank statements to assess your character, they will take into account your spending patterns and consistency.
Conditions will vary depending on the type of loan you get, and is generally best described as the purpose for the loan and whether the lender deems this to be a low-risk or high-risk option.
For example, you’re a motorcycle mechanic and you want to borrow $3,000 to buy a busted-up motorcycle, but you can very clearly illustrate that you’ll not only fix the bike, but be able to sell it on shortly afterwards for a profit and repay the loan in full.
This type of condition is more likely to get a favourable rate than, say, a loan used primarily to cover other debts or repay bills, where the loan isn’t used for a purpose other than to cover existing, unmanageable debts.
Capacity is simply the most important factor of risk assessment and broadly covers your ability to repay the loan amount. Quite simply, this is whether you have the incoming earnings capable of meeting the required repayments for your loan amount over the period you wish to borrow it for.
The amount you can borrow, and the length of time you wish to repay the principal amount, will be determined almost entirely by your capacity.
The supporting documents you’ll need to supply with your application will depend on the type of finance you’re applying for and the specific lender requirements.
Lenders will actually be looking at a lot of different information from your statements, to help them with their decision to give you a loan - the most useful of these documents is your bank statements.
Your bank statements:
Lenders use financial technology to assess your bank statements to make a final decision on your financial strength and ability to repay your loan. Below we’ll look at the most common factors that can affect your bank statement assessment.
If you do have existing debts, your potential new lender will need to know how much you are paying each month and how much is still outstanding, so they can assess your capacity to service their loan too.
If you don’t have bank statements, lenders will need to use alternative documentation to assess your application. Applying without the standard documentation is called a ‘Low Documentation’ or ‘Low-Doc’ loan.
Applying for a low-doc personal loan may not require the standard documentation for approval, but you’ll still need to demonstrate to your lender that you can repay your loan amount. You may be asked to provide:
Shaun is the founder of Money.com.au and is determined to help people pay as little as possible for financial products. Through education and building world class technology. Previously Shaun co-founded CarLoans.com.au and Lend.
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