Granting Loans

Objectives Describe the five C’s of credit Explain how commercial loans are evaluated Describe the steps in applying for a loan

Five C’s of Credit Banks look at the customer’s creditworthiness…an assessment of a borrower’s ability to repay a loan Banks must look at the applicants complete financial picture…character, capacity, capital, collateral, and conditions

Five C’s of Credit: Character Character is a loan applicant’s honesty and integrity as shown by how he or she handles debt Have you used credit in the past? Have all your bills been paid on time? How long have you had your current job? How long have you lived at your current address? Businesses have character too

Five C’s of Credit: Capacity Capacity is a loan applicants ability to pay debts as shown by cash flow Lender looks at the amount of money going out (expenses) and the amount of money coming in (income) What are your current expenses How much money do you owe? What is your current income? Is your income steady? Individuals: Lenders look for steady employment a salary that can cover expenses and debt Businesses: Lenders look for steady profit over time

Five C’s of Credit: Capital Capital is a loan applicant’s money, property, and other valuables If a borrower has valuables they can be used for collateral but if not then the loan may represent a greater risk for the bank

Five C’s of Credit: Collateral Collateral is used to back up a loan The less collateral a borrower has, the riskier the loan is for the bank A bank will only consider certain assets as collateral…which must be easily liquidated and may have to be appraised to determine its value

Five C’s of Credit: Conditions Conditions involve the overall environment in which the loan will be given For example, if you work for a company that has widespread layoffs, this may be a factor that the bank sees as a great risk Or if the house you are wanting to buy is in an area where the value of the homes has decreased a great deal…the bank may see this as a risk But on the other hand if you have had an account with the bank for 30 years and never bounced a check or defaulted on any other loans, this may go in your favor

Credit Scores Credit score – a measure of risk based on the borrower’s credit history Risk – the likelihood of financial loss caused by a borrower failing to repay the principal and interest as specified in a loan Like a grade on a test…the higher the better A higher credit score means the customer is a lower risk and will probably pay debts in a timely manner Generally those with a high credit score will be more likely to be approved for loans than applicants with low credit scores If both are approved the applicant with a high score will probably have a lower interest rate

Credit Scores Credit bureau – a company that gathers, analyzes, and summarizes credit-related information on consumers Equifax, Experian, and TransUnion…information only FICO score is used by most lenders…credit rating used by lenders to predict an applicant’s ability and willingness to repay loans

Credit Scores FICO was created by Fair Isaac Corporation Composed of five elements Payment history Amount owed or outstanding debt Length of credit history New credit Types of credit used Ranges from 300 to 850 A score is not permanent…it is ever changing as consumers get new loans and pay off debt

Credit for Commercial Loans To assess the risk involved with commercial loans, lenders look at the company or organization's: Balance sheet shows a company’s assets Cash flow represents the what money is coming in and what money is going out If the company has more money coming in, the company has a positive cash flow…how much positive cash flow is a factor in determining if a loan is approved and for how much Collateral is a factor in all secured loans Lenders use specific formulas to determine the value of a company’s collateral (office buildings, manufacturing equipment, accounts receivable, and even patents and other intellectual material…ideas)

Credit for Commercial Loans Debt Ratios are another factor…they compare debt to income or assets…the greater the ration, the greater the risk is to the lender Debt-to-income Debt-service-coverage ratio Loan-to-value ratio

Credit-Application Process Sometimes banks charge for the credit application when a customer applies for a loan Maybe small or as much as a few hundred dollars Pays for verifying employment, credit, and other background information If the applicant isn’t approved for the loan…the fee is not returned Cosigner – an individual who sign the loan with the borrower…taking on equal liability for repayment

Loan Application Process Customer completes application Applying Customers provide income tax forms, pay stubs, and other documents Documenting Bank will verify all submitted information Submitting When lenders analyze risks and set conditions on the loan Underwriting If approved by the underwriter, the loan is approved Approving Signing the loan agreement Closing Borrower receives the amount of the loan…in the case of a mortgage loan, the sell receives the funds Funding