Credit Appraisal – Everything You Need to Know

Did you ever wonder why loans get approved by financial institutions like banks, but sometimes get rejected? Every bank follows its own set of eligibility criteria to be met by the borrowers when applying for a loan. This is where the role of credit appraisal comes in. Credit appraisal makes it easier for banks “to lend or not to lend” a Personal loan.

Considered one of the most crucial steps in the loan application process, credit appraisal helps decide the fate of your application for your personal loan or credit card. Also known as credit evaluation, the credit appraisal process assists lenders in reducing risk, as it assesses the applicant’s process and the ability to repay. In general, lending agencies evaluate your financial credibility to determine whether or not you can repay the bank’s loan or the outstanding amount on the credit card.

Do you have an idea what credit appraisal is all about? If not, don’t fret; you have landed on the right page.

This blog will highlight essential details about credit appraisal’s meaning, eligibility criteria, benefits, factors, process, and importance.

What is Credit Appraisal?

Credit appraisal is a procedure used extensively by banks and financial institutions to assess the borrower’s ability to repay a personal loan. Lending agencies examine your past payments to gain insights into your payment patterns. This makes it easier for them to calculate the risk involved in the money lent by banks and NBFCs (Non-banking Financial Companies). 

These financial institutions rely on various credit appraisal techniques to comprehend how risky the borrower may be. If the risk is higher, the chances of the application for a personal loan or credit card approval are lower. 

Banks and lending agencies consider various factors that offer insights into the person’s borrowing capacity. Factors, such as income level, repayment history, and current debt levels, are considered by banks and other lending institutions. The credit score is another essential aspect of the credit appraisal process.

Eligibility Criteria for Credit Appraisal

The eligibility criteria for credit appraisal depend on a person Applying for a personal loan. Here is a list of some usual requirements that lenders want individuals to meet:

• Income Stability: Lending agencies look into the borrower’s financial situation to determine if a borrower is in a position to make loan repayments on time. Hence, the income is one of the major components of the eligibility requirements.
• Credit History: Your credit history is a significant factor in assessing your loan application. This is because lending agencies consider your credit history a part of the credit appraisal process.
• Collateral: Lending institutions evaluate the collateral offered when providing a secured loan to an individual. Acting as a safeguard, the collateral enables lending agencies to recover their funds if the borrower cannot repay or default on the loan.
• Debt-to-Income Ratio: The debt-to-income ratio helps evaluate the borrower’s financial position concerning their current income. If the ratio is lower, the current debts will also be lower. This denotes that the repayment capacity is higher.

1. Loan-to-Cost Ratio: This ratio compares the loan amount with the end goal’s cost for which the borrower will use the funds. It assists lending agencies in deciding on the loan amount a bank or financial institution can grant.

Benefits of Credit Appraisal

Here is a list of some of the most significant benefits of the credit appraisal process:

• Reducing Credit Risk: Lending agencies thoroughly evaluate a borrower’s debt-paying ability. Doing so helps them identify potential defaulters and keep away from loans involving high risks. Hence, they can alleviate the risk of bad debts.
• Ensuring Fund Safety: The credit appraisal process certifies that loans are extended to borrowers who can repay them. Thus, the funds of the financial institutions are protected.
• Confidence Among Banks: Since an individual’s creditworthiness has been determined, banks and lending agencies get a sense of security that the borrower will pay the installments.
• Optimizing Loan Terms: Based on the credit appraisal, lending institutions can customize loan conditions including interest rates and repayment schedules. This is done to help meet the financial circumstances of the borrower.
• Helps Determine the Loan Amount: Depending on a person’s credit reputation, the amount they can borrow as a loan is decided. The borrower must repay the amount so the banks do not suffer a financial loss.

Factors to Consider During the Credit Appraisal Process

Listed below are some of the vital factors considered by lending agencies and financial institutions for evaluation purposes:

• Income: The individual’s total income is examined to understand if the borrower has a fixed income and job stability. 
• Assets Owned: The bank assesses and keeps this piece of significant information so it can be used as a collateral. This applies if the borrower is unable to repay the amount they borrowed.
• Liabilities: This verifies that the borrower has not missed or defaulted on any previous payments. They must have minimum liabilities they can easily afford to repay.
• Repayment Capability: A crucial factor that must be considered in the individual’s repayment capability is their capacity to repay the amount borrowed from the bank. If their repayment capability is higher, their chance for credit approval is better.

The Credit Appraisal Process

Before you apply for a credit facility, it helps you understand how lending institutions assess your creditworthiness. Refer to some useful steps usually involved in the credit appraisal process.

1. Application Processing: The bank or any other lending agency processes the application submitted by the individual. All the relevant information in the application is evaluated and scrutinized.

• Documentation: The borrower must submit all the documents the lending agency requires. These include identity proof, income proof, bank statements, and more. 
• Credit Assessment: The lending agency investigates the credit history, existing debts (if any), and financial stability of the borrower. This will help them get a clear picture of their credit situation.
• Financial and Risk Assessment: Henceforth, the lending agency assesses the financial stability and repayment capacity of the borrower. Moreover, they will consider their credit risk level.
• Loan Structuring: If the appraisal of the borrower’s credit standing, financial situation, and risk is positive, the lending agency determines the loan terms. These include the amount, rate of interest, and repayment tenure.
• Approval and Administration: Other than approving the Emergency loan application, the lending agency disburses the amount to the borrower. Then the financial institution must provide the loan and ensure the records are regularly updated.

Importance of Credit Appraisal

Credit appraisal techniques play an important role. They assist the lending agency in evaluating the borrower’s repayment capacity. Also, they help them determine the loan terms and structure and other credit facilities.

Credit appraisal is important because:

• It helps the lending agency conduct a highly effective risk evaluation of the borrower.
• It establishes the borrower’s financial credibility.
• It is vital in determining the loan amount and rates of interest.
• It promotes confidence among banks and other financial institutions about the borrower’s repayment ability.

Final Words

Credit appraisal is an indispensable process for lending agencies to follow. This is because it helps them ensure that the borrower is someone they can trust and has good credit standing when releasing funds. The borrower must have the capability to pay back the borrowed amount. Doing so will help banks avoid bad debts and financial losses. Credit appraisal is an efficient process that proves beneficial for the lender and the borrower.