Whenever you discuss personal loans or read about loans in general, you may have come across the term ‘credit appraisal’. Credit appraisal basically refers to assessing a particular loan application or proposal in a thorough manner in order to gauge the repayment ability of the loan applicant. A lender conducts a credit appraisal chiefly to make certain that the bank gets back the money that it lends to its customers.
Whether one applies individually or as a corporate entity, a lender always conducts a detailed and systematic credit appraisal process. The credit appraisal process before giving a loan to entities is comprehensive in nature as it appraises or evaluates management, market, technical, and financial elements.
No lender approves and sanctions anybody’s personal loan application instantly without an evaluation. It is absolutely important for a lender to carry out a credit appraisal process in order to ensure that the borrower has the capacity to repay the entire loan amount on time without missing any payment deadlines. This is very crucial for a bank as this determines the interest income and the capital of the bank. The repayment behaviour of a borrower directly affects the performance of the bank.
Both banks and non-banking financial corporations (NBFCs) utilise credit appraisal procedures before approving a personal loan application or any other loan application. Each lender will have its own techniques for performing credit appraisal processes. A lender will have certain norms, rules, and standards to assess the creditworthiness of a particular loan applicant. If a borrower has a high creditworthiness, there is high probability that his or her loan application will be accepted by the bank. A credit appraisal is done to avoid the risk of default on loans.
In the context of loans and credit, creditworthiness broadly refers to the financial character of a particular individual. When a person applies for a loan, the lender will check this financial character to get an idea of how the applicant treats his or her debts.
The lender will check the borrower’s credit history. This will comprise checking his or her repayment behaviour, time taken to pay different equated monthly installments (EMIs), how a borrower has treated his or her different debt obligations, etc.
In order to compute the creditworthiness of a borrower, a credit analysis needs to be performed. Apart from checking the credit history of a borrower, a lender will also evaluate his or her credit score. A credit score refers to a particular score that is given to a borrower depending on his or her credit history. This score is provided by credit bureaus who will evaluate one’s full repayment behaviour and give them a score. It will be based on credit reports created by credit bureaus. Hence, if one is interested in applying for a personal loan, a car loan or any other loan, he or she should make sure that their credit score is good. In India, the credit score of any loan applicant should ideally be 750 and above.
In India, CIBIL is the leading credit bureau that takes care of observing your credit behaviour and preparing a credit report with details of your credit score. You can check your CIBIL report to get an idea of your credit history.
In case your credit score is high, you can be positive that your loan application will be approved, provided you meet other eligibility criteria set by your lender. If your credit score is low, you can take specific measures in order to increase it. When you incorporate good measures to enhance your credit score, you widen your scope to get your loan approved by the bank. You will have to be extremely financially disciplined to increase your credit score.
A lender’s credit appraisal process will typically check and evaluate the following important factors:
A lender typically compares your loan amount, income, EMIs, repayment capacity, and your overall expenses in order to determine if you are eligible or not to get a personal loan or any other loan. Generally, banks and NBFCs take a look at certain ratios in order to check your loan eligibility. These are some of the ratios that are useful in the credit appraisal process:
Finding out the loan eligibility of a loan applicant will assist a lender in fixing the loan amount that needs to be offered to the applicant.
Bankability is a very important aspect that is a part of credit appraisal. Bankability refers to what will be accepted by a particular bank. A lender will assess if a loan given to a particular person will result in future cash flow and profitability.
When you apply for a personal loan or any other loan from a bank or an NBFC, you will be required to mandatorily furnish certain government-approved documents, reports, and other documents in order to prove your income, age, and other aspects. These norms will vary from lender to lender. While applying for your loan, your lender will specify the norms and you will be required to follow them so that they can decide if the loan can be approved or not. Let us take a look at some of the common norms that are set by lenders for the credit appraisal process:
In order to prove your monthly income, you will be required to submit certain documents and they include:
To prove your residential address, you will have to furnish any one of the following documents:
To prove your identity and date of birth, you will be required to submit any one of the following documents:
To prove your employment information, you will be required to give certain documents regarding your employer or your own company (if you are self-employed):
To prove your creditworthiness, you can show your credit score to your new lender. This can be done by submitting your CIBIL report. When you are furnishing your CIBIL report, you should be sure about the details of your credit score. You should also ensure that your credit score is 750 and above.
With the help of your CIBIL report, your lender will check if you have been prompt while making your repayments and while clearing your credit card bills. Your lender will also be able to see if you have defaulted any loan during your entire credit history and if you have made many enquiries. Hence, you need to be very particular about how your credit report looks.
If you have made any investment, you will be required to provide proofs. This can be done by giving documents of your investments such as fixed deposits, shares, mutual funds, fixed assets, gold, etc.
When the lender takes a look at your income proof, age proof, and employment proof, the lender gets an idea about your overall profile and the bank can determine if you will be able to repay your loan promptly without any financial struggles.
If a lender is approached by a company for project financing or a loan, then the lender will need to consider financial, technical, commercial, market, and managerial aspects of the organisation.
Banks will assess both financial and non-financial aspects in order to determine the borrower’s creditworthiness while conducting the credit appraisal process.
The intensity of the credit appraisal will depend on the loan quantum and the purpose of the loan. According to these aspects, the appraisal process can be simple or complex for both individuals and entities.