06 Feb What does a financier look for when providing credit?

When deciding whether or not to lend, credit providers assess a variety of information based a variety of factors.

Books have been written on the subject but I’ll do my best to cover some key principles in a concise format.

The principles I am referring to are 3 C’s of Credit. They are used to determine the comfort level the credit provider has with the risk in lending to a customer.

Cash Flow

One of the first things a credit provider will look at. How much excess cash flow does the customer have?

This means collecting proof of income. Also for the other side of the equation, expense information can be requested as well.

These figures are then inputted into a servicing calculator to see how much excess cash flow the customer has to pay back the loan

Based on serviceability customers are risk rated. In some instances, customers with different risk profiles are charged differently.

Collateral

A customer paying back a loan is only one way the bank can ensure it will recoup its investment.

For further security, a bank can ask for an asset they can sell in the event of a default. Otherwise known as collateral on the loan.

It is usually (but not always) the asset the financier is lending for.

They will assess the price of this asset and how and if the bank can sell it later down the track to get their money back.

If the asset has poor resale value generally pricing of the loan increases. There are also obviously unsecured loans which attract an even higher price increase.

Character

The most overlooked yet maybe the most important C

Character.

Years ago this was a bank manager looking the individual asking for money in the eye and listening to their gut.

In a way not much has changed.

Banks want to deal with customers who will uphold their obligations in an agreement.

This will involve making sure there aren’t any glaring red flags, and more specifically paying close attention the credit checks and references on the deal.