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

Payment History: Are payments late? If so,

how late? How re-cently was a payment

late? How many payments are cur-rently late? 35%

Length of Credit His-tory: How long has

each account been es-tablished? How re-cently was each ac-

count active?15%

Types of Credit Used: What types of accounts does the applicant have? Loans? Mortgages?

Credit Cards?10%

Amount Owed: How many accounts have a balance? How much is owed on each account?

30%

New Credit: How many accounts have been opened recently? Have other potential lenders

checked the FICO score recently?10%

FICO Score Elements

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 applicationApplying• Customers provide income tax forms, pay stubs, and other

documentsDocumenting• Bank will verify all submitted informationSubmitting• When lenders analyze risks and set conditions on the loanUnderwriting• If approved by the underwriter, the loan is approvedApproving• Signing the loan agreementClosing• Borrower receives the amount of the loan…in the case of a

mortgage loan, the sell receives the fundsFunding