5c of Credit Underwriting

Capacity Capacity measures the capacity or capability of the individual/ business to repay the loan amount in time. It is the first step for any credit application to get reviewed positively. In case the applicant does not have capacity to repay, chances arehigher that the lending institution will reject the application or review it for a lower amount to lend which the underwriter feels, is within the borrower’s repayment means. Furthermore, the underwriter examines Credit Capacity, Current Income and Stability of income (Salaried Segment and Self–Employed Segment). Credit Capacity Credit capacity means how much credit you are able to handle. It is actually a mathematical calculation based on income and expenses of an individual.  This is measured at 2 levels. At first, the underwriter checks on current income level, and then assesses stability of income. Both of these are necessary to ensure the loan repayment sustains over its designed tenure. Current Income To check the credit capacity, the underwriter takes Debt–to–Income ratio in consideration. From the documents of an individual the capacity of repayment is ascertained by the borrower.  
                                      DTI = Total of Monthly Debt Payments/ Gross Monthly Income
        Underwriters commonly use a Debt–to–Income (DTI) to evaluate an applicant’s current capacity to repay. Mathematically speaking, DTI is the ratio of total monthly obligations to total monthly income. In India 21 % – 35 % DTI is considered a safe side and with such %, there is a higher chance that you get an easy approval of any loan. This refers to the fact that an applicant can avail a loan to the extent where his monthly obligations (EMIs) are not more than half of his monthly income. To understand it in a better way, let’s look at this illustration. Stability of Income Continuous or regular income flow is necessary to prove your credit capacity. In the current volatile market, there is a high chance that your income flow is affected. The current COVID– 19 pandemic, 2020 crisis had a cascading effect on the global economy. Consequently, several sectors like, hotel and tourism, real estate, export, among others, were severely impacted which led to both business and job losses. Stability or continuity of income is very essential as the loan is to be serviced for a longer period or tenure. To check on stability of income, underwriter further verifies the other factors as well such as: Salaried Segment
  • Organization of applicant means multinational company or domestic company, public limited or privately held company etc
  • Position in the organization
  • Duration of employment (Total as well as with the same company)
  • Work experience across the career
Self–employed Segment
  • Education
  • Entity Status means proprietorship, partnership, limited company, LLP etc
  • Length of business operation
  • Types/Profile of business
  • Gross turn over
  • Cash flow in the bank statement
In conclusion when all of the above views considered together, give an indication about stability and sustainability of future earnings.  This helps the underwriter with next step for further proceedings.   Character Character is the most important factor in evaluation of creditworthiness. It refers to the willingness or intention of repaying. The assessment of character of applicants is the most important step for any underwriter in the credit evaluation process. For this underwriter mostly refers to the credit history of repayment in your credit report. Past defaults imply negligence or irresponsibility, which are undesirable character traits. Before 2006, when credit bureaus were not present, lending institutions had to rely on some informal agencies like verification agencies which were not always genuine or accurate, as all information was subjective and was only heard and seen. Hence, the decision process was hampered and getting a bias –free decision was difficult. Measuring anyone’s character is a complex process and it is a subjective matter which includes high probability for bias and misinterpretation. Underwriter could determine Credit Character based on the following four methods: 1 Face–to–Face Meeting with borrower to assess the character 2 Internal Database check 3 Benchmarking the applicant (based on past lending experience) against performance of peer group/age group/geography and other factors   4 Assessment of all factors related to his/her previous borrowing records with other lending institution   We cannot deny the fact that if data quality is high, data or records quantity is adequate and the decision mechanism is objective then it is ideal to arrive at effective decision making. In this regard, the credit bureau plays a vital and important role. Collateral Collateral means a pledge of some asset by borrowers to lending institutions. A credit secured with collateral is called a secured credit and carries lower risk thanthe one without collateral is called an unsecured credit. Once the credit capacity and character are evaluated then a loan application is reviewed in the light of collateral. Generally, secured credit is easily approved as the applicant is giving surety with collateral compared to unsecured credit. Collateral is a kind of security against a loan which a lender can dispose of to recover the outstanding amount and loss/expenses (if any) in case a borrower failed to repay or defaulted on loan. This is considered less risky for lenders though it involves tedious process to assess the value of collaterals as the underwriter needs to review many aspects such as current valuation of property, expected price fluctuations over time and any external factor which can lead the market to be volatile (This could even be on the account of natural calamities and various domestic or international events which are beyond someone’s control. Recently we have come across COVID –19 pandemic, 2020). Condition Condition refers to specific conditions such as interest rate or principal amount etc. The underwriter assesses the risk based on borrowers’ plans to use money. Consider a borrower who applies for a car loan or a home improvement loan. A lender may be more likely to approve those loans because of their specific purpose, rather than a personal loan, which could be used for anything. Additionally, lenders may consider conditions that are outside of the borrower’s control, such as the state of the economy, industry trends, or pending legislative changes. Capital Capital refers to overall assessment under the name of the borrower. It represents one’s investment, savings and other assets like land, jewelry etc. In general, loans can be repaid by regular income flow but capital is additional security in case of any unforeseen situation or setbacks such as unemployment. Down Payment size can also affect the interest rate and terms of borrower’s loan. In nutshell, whenever you go to a lending institution with a loan application, your loan application has to get a green flag (required eligibility) under the 5Cs framework to be eligible for getting a loan. Any Red Flag (means not required eligibility) will lead to lower your chance to get a loan.

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