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    Credit Appraisal

    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.

    How Does a Lender Assess the Creditworthiness of an Individual Borrower?

    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.

    What is Credit Score?

    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.

    Factors Evaluated During a Credit Appraisal Process

    A lender’s credit appraisal process will typically check and evaluate the following important factors:

    • Income
    • Age
    • Repayment ability
    • Work experience
    • Present and former loans
    • Nature of employment
    • Other monthly expenses
    • Future liabilities
    • Previous loan records
    • Tax history
    • Financing pattern
    • Assets owned

    How Does a Lender Evaluate the Eligibility of a Borrower Through Credit Appraisal?

    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:

    • Fixed obligation to income ratio (FOIR): This ratio refers to how one deals with his or her debts and how often they repay their debts. It refers to the ratio of the loan obligations and other expenses to the income that they earn on a monthly basis. The bank will assess if a certain portion of your income is sufficient to manage your EMIs for the loan that you have applied for and for your other liabilities. If the ratio is higher than the benchmark fixed by the lender, then the lender may not accept the application.
    • Installment to income ratio (IIR): This ratio considers the equated monthly installments (EMIs) of your loan to the income that you earn. It will indicate the amount you will be required to take from your income to pay your personal loan EMI.
    • Loan to cost ratio: This ratio indicates the maximum amount that a particular borrower is eligible to take. This will depend on the cost of the car if you are taking a car loan and on the cost of the house if you are taking a home loan. For a personal loan, it will depend on your personal requirement. Usually, the ratio will range from 70 to 90% of the cost of the car or house.

    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.

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    Submission of Documents for Proving Your Bankability

    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:

    Proof of income

    In order to prove your monthly income, you will be required to submit certain documents and they include:

    • Most recent bank statements for 3 to 6 months
    • Most recent salary slips
    • Most recent Income Tax Return (for self-employed individuals)
    • Audited financials for the previous 2 years

    Proof of address

    To prove your residential address, you will have to furnish any one of the following documents:

    • Leave and license agreement
    • Latest electricity bills or utility bills
    • Aadhaar card
    • Driving license
    • Passport

    Proof of identity

    To prove your identity and date of birth, you will be required to submit any one of the following documents:

    • Aadhaar
    • PAN card
    • Voter ID
    • Driving license
    • Passport-size photographs

    Proof of employment

    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):

    • Letter from your employer
    • Offer letter or appointment letter provided by your employer
    • Office address proof
    • Employment certificate from your present employer
    • Certificate of experience or relieving letter from your previous employer(s) to show your overall work experience

    Proof of creditworthiness

    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.

    Proof of investment

    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.

    Credit Appraisal for Project Financing for Organisations

    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.

    • Under credit appraisal, to evaluate financial aspects, the bank will have to check the organisation’s costs, expenses, and estimated revenues in order to understand if the company will be able to repay the loan without any trouble.
    • To assess technical aspects of a company, the bank will have to evaluate the nature of the business and the industry or sector of the borrower. The lender will have to observe the company’s raw materials, capital, labour, transportation, selling plans, etc.
    • To evaluate the market of the borrower, the bank will have to evaluate its demand and supply. If the demand-supply gap is high, then it is great news for the lender. This is because it indicates that the company will enjoy good sales and hence, can repay the loan efficiently.
    • The bank also needs to assess the managerial aspects of an organisation before giving a loan to them. The bank should understand the goals, plans, and commitment of the company to the particular project. The organisation’s management style and ways of handling subordinates should be observed by the lender.

    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.

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