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3 Common Criteria Banks Use to Assess Your Eligibility for Bank Loan
Every day, thousands of people are rejected elsewhere around the world by the banks from obtaining the bank loan they seek. It is really a frustrating experience. Anyone who has in his lifetime tried to obtain a bank loan, especially here in Papua New Guinea will tell you that it is not a straight forward, easy-go-get-it process.
There are different purposes why individuals approach banks for loans. However, what you learn in this hub, applies to any situation. As a matter of fact, if you don’t get these three right, you risk outright rejection from the banks. You should never blame the banks. Banks are in business to make money and it is only right that they protect their money from unscrupulous participants, who can take money but cannot repay.
Borrowing money can be a daunting task as most people are not familiar with the financial formulas and usually have no idea how to work out the basics of what to do before talking to a lender. In this hub, I wish to show you three things you must have before you approach the lender.
Criteria 1: Status
If the banks are going to lend you a lot of money, then they will need to know about your personal status before they even look at your finances. Don’t be put off by the details required. Apart from usual name, address and phone numbers, they will also want to know some other personal details including;
- If you are resident or non-resident in the country you live at present
- How long you have lived in your present address
- How long you lived in your last address
- Your employment status. Employed or self employed
- Your current employers address if you employed. How long you have worked here
- If you have a partner or not
- Your partners employment status
- Number of dependents
- If you have been bankrupt or not
- How many credit cards you have
And many other relevant details
Lenders try to determine whether or not you are a good risk as they prefer people who have stable employment and who have lived at the same address for a reasonable time. They are no hard and fast rules on who constitute the right client, but if you have five kinds, have been unemployed for six years and have lived at four different places during that time, then you might struggle to get a loan. Lenders may go out to loan money to those who have been in the same address for a long time and have stable income.
Self-employed may find themselves in difficult situation at times as most banks would rather threat them cautiously. For tax purposes, it is better to show minimum income with maximum expenses. However, they may find that their tax returns disadvantage them in applying for a loan despite pleas like “But I earn more than what’s showing there’ and ‘I don’t really have many expenses’
No one has any legal obligation to approve a loan. Not even if you financial details fit the lenders guidelines. Therefore if it is important to prepare a loan application information that presents you in a good light.
Criteria 2: Security
Imagine if you went to a service station, put $20 worth of petrol in your tank, than later realize you left your wallet at home? The attendant will never let you drive home to get your wallet no matter how sincere and trusty worthy you seem to be. What would you do in such a situation? Maybe you can live behind your Rolex watch worth over $5000 with the attendant as security guarantying your return. This is overkill. Or if you supplied your $200 worth of wedding ring, you may still be lucky. What if you wanted to live behind a $10 pocket knife? I don’t think this may work.
Lending institutions work the same way. If you have to borrow big money from the bank, then must have supply something as security to guarantee the bank that you will repay their money with interest.
There is a relationship between value of security lenders need and the loan they are willing to advance. This is call Loan to Value Ratio (LVR).
A watch with LVR of 1% is excessive security and the pocket knife with LVR of 500% is insufficient, while the ring with LVR of 25% would probably be right in this situation. LVR is the key to borrowing money from the banks. Before you ask the lender for money, find out what the lenders LVR is so you save yourself time and wasted effort. The LVR may differ from bank to bank so snoop around and find the one that fits your situation.
Criteria 3: Serviceability
Ok, you have successfully passed criteria one and two. You have the personal and financial status required. You have the security in hand. Now what? Serviceability. The next step is the banks will try to determine if you can repay or more technically service the loan as you say.
Key information required to calculate your serviceability;
- Personal income the borrower
- Personal income of the borrower’s partner
- Other income
- Personal living expenses
- Current loan payments (if any)
- Future expenses (if any)
Note: The lender may also ask for other details as they see fit.
Incorporating all this information together, the lenders form a formula that they use to assess your eligibility for the loan. There are at least 17 different ways in which this information is manipulated to and as such, different names given them. I list them here for your convenience: Affordability Index, Cash Flow Test, Net Surplus Ratio, Gearing Ratio, Debt Qualifier, Net Income Test or Debt Service Ratio (DSR), which I prefer to use and will use in this hub. All of them mean the same thing but may be broken down to something like;
30% Total wages + 80% Total rent > Total loan repayment
There are different ways lenders calculate DSR. I choose to use a method that bears resemblance to the LVR formula to make it easy for you to remember.
Loan payments are the total of all payments including, home, car, boat, investments etc, and eligible income is 30% of total wages plus 80% of all rent. If this ratio is 100% or less, the loan proposition is considered acceptable.
Before we conclude, I want you to watch this powerful video by Brian Tracy
We covered in this hub, three criterias you must meet to increase your odds of being successfully granted a bank loan. They are status, security and serviceability. Your aim must be to prepare your loan application documents in such a way that it puts you on a more advantageous position to get the loan. There is no 100% guarantee that if you get the three right, you automatically will be given the loan you seek. However, with better preparation, you will greatly reduce the risk of being rejected.
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© 2014 Ian D Hetri