Factors considered by a lender
When you apply to borrow money, the lending party takes into account a number of considerations that will lead to accepting or rejecting your application. This chapter outlines some of the factors that lenders consider when assessing a borrower.
The lender
Every loan carries a degree of risk for a lender, because there is no method of knowing that a borrower will definitely repay the amount borrowed. In loaning money, a lender takes a calculated chance on the borrower, therefore approval may rest with the lender's willingness to take that chance.
Some financial institutions have strict guidelines that they use to identify potentially risky borrowers. If these potential borrowers do not meet the guidelines required by the lender, then they cannot borrow money from that lender. Other lenders may be more lenient about who borrows from them but as compensation for accepting a higher risk, these lenders will generally charge a higher rate of interest.
Lenders may also have a limit to the amount that you can borrow, corresponding to the amount that they have available to lend. Large banks can afford to risk greater amounts of money than a pawnbroker does, for example, so you would go to a bank to secure a housing loan rather than a pawnbroker.
The loan
The lender will assess the stakes involved with loaning the money, including the amount borrowed, the loan period and the lender's potential gain, including anything used as security to guarantee the loan.
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The type of loan, and therefore the amount, will greatly affect whether a lender will approve a loan. In general, the smaller the loan the lower the risk, so a lender will more likely approve a small loan in context with the borrower's ability to repay it. A small loan usually has a shorter loan period and a high interest yield, which is also in the lender's favour.
If you can nominate an asset to secure a loan, then a lender is more likely to accept a loan application because s/he stands to gain something in the event that you default on your repayments. This is especially important for large loans, such as money borrowed to purchase property, where the lender may have the option of selling your house to recoup any losses suffered because of your inability to repay them.
The borrower
Your personal circumstances play a large role in a lender's decision to accept your loan application. The lender will take into account your financial position including your income, assets and liabilities, your history of borrowing and a guarantor's willingness to take on your debt should you fail to repay it.
Lenders prefer that you earn a reliable income as it indicates that you have regular money coming in and can therefore meet periodic installments to repay the loan. The lender also sees even less risk in lending money to someone who is in stable employment earning a lot of money, which is why he or she would prefer to lend money to people working full-time to a casual employee.
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Your assets also contribute to a lender's idea of whether you are a risk. If you can show that you can save money, such as through a record of savings or investments, or if you have already acquired things of value, such as property, then a lender may take into account that you have good financial management skills and/or something that you can use (or sell) to guarantee repayment.
If you have any significant liabilities, financial commitments that would negatively affect your income, then the lender would view you as more of a risk. Even if the potential borrower has a high income, if they also have a number of liabilities - for example, they are the sole financial provider for their family of seven, or if they have other debts - it will affect their capacity to successfully repay a loan.
Earlier we mentioned that a credit rating is a record kept by lending institutions showing a history of your borrowing and repayment habits. Your history of borrowing will affect a lender's risk assessment - if you have not borrowed before, then lenders may regard you as an unknown risk. If you have a good credit rating, a lender will see this as a sign that you are more likely to meet repayments and therefore less of a risk, or the opposite may be true if you have a bad credit rating.
If the lender believes that you are a high-risk borrower, they may look to a low-risk borrower to guarantee the loan. A guarantor is a low-risk borrower responsible for ensuring that a high-risk borrower repays the loan. If the high-risk borrower fails to make repayments, a guarantor will assume the debt on their behalf.
