Factors Determining Loan Approval
Lending institutions determine the creditworthiness of the borrower before granting them the loan so as to mitigate the risk of credit default. All the lenders have their own criteria, but primarily the factors stated below are considered while approving a loan application.
- Credit Score: A loan provider needs to know which applicants are most and least likely to honor their loan obligations. Lenders use borrower’s credit scores to assess credit risk. These scores take payment history, the current level of indebtedness, length of credit history, opening of the new credit accounts, and the amount of credit outstanding while determining the creditworthiness of an applicant.Generally, a credit score in the range of 700 to 800 increases the likelihood of loan approval but, credit score of less than 300 increases the chances of rejection of the application.
a)Payment History :Payment behavior of an individual in the past is an indicator of the creditworthiness of an individual.
b)Current level of indebtedness :It is the ratio of money owed to the amount of credit available.
c)Types of credit used: To obtain high credit scores, individuals need a mix of credit accounts like credit cards, installment loans such as signature loans or vehicle loans, and mortgages.
d )Length of credit history: As a general rule of thumb, longer the credit history of an individual , better is the credit score of an individual.
e)New credit accounts :If the borrower has opened a bunch of new credit accounts in a short span of time, it indicates the need of credit by the borrower ,and it is an indicator of his poor financial health.
2.Income:Higher monthly household income increases the likelihood of approval of the loan application. For Example, if the loan requires the applicant to make the payments of Rs 10,000 per month and his/her monthly household income after deducting all the EMI payments is Rs 100,000 then the chances of the approval of loan increases.
3. Proof of income & Investment Statements: Applicant’s are required to submit the income proofs in the form of pay slips, bank statements, or income tax returns to get their loan application approved.
4. Employment history: Lenders often look for stable employment while determining the borrower’s creditworthiness.
5. Education Background: Lenders often look for the education background of the borrower to enable decision making on the loan approval process for applicants with missing credit history.
6. Debt-to-income ratio: Sometimes broken down as a payment-to-income ratio, this factor calculates debt as a percentage of the applicant’s income. The debt-to-income ratio below 36 percent is considered good. On the other hand, a higher ratio increases the probability of rejection of the loan application.
7. Credit Inquiries/Loan Applications: The more credit inquiries a person makes in a time frame the less likely he will get a loan.
8. Age: The earnings of an employee increases with work experience or age.However, if an individual applies for the home loan in the retirement years then the chances of rejection of the application increases due to fewer number of earning years for loan repayment.
9. Collateral: The collateral provided by the loan applicant to the bank while applying the loan can increase the probability of the loan approval.
Credit Score is one of the primary factors in determining approval of the loan application because it provides key insights on the borrower’s payment behavior.However, it’s not the only thing lenders look at while making a decision to grant loan to an applicant.The lender’s decision is also influenced by the applicant’s income,education,age,debt to income ratio,stable employment ,and the number of credit inquiries made.