In financial markets, a loan basically is a borrowing of funds by one or more people, institutions, companies, or other entities for the purpose of using the funds as they are owed. The borrower is typically responsible to repay principal and interest on this debt before it is paid off and to eventually repay the total amount borrowed. While interest rates on loans are variable, a loan generally is not considered a risk-free investment unless the lender has complete faith in the repayment capabilities of the borrower. For instance, if you have good credit and the lender feels you’ll be able to make your repayments regularly, he may offer you an attractive fixed rate loan with favourable terms. However, if things go awry and you find yourself unable to meet the repayment schedule, you have just suffered a major loss.
As you may be aware, lenders categorize various risks associated with providing money to different people, companies, enterprises etc. The most critical risk to any lender is creditworthiness. Creditworthiness is equated with a borrower’s capacity to repay a loan as and when required. A major part of this risk is evaluation of a borrower’s current and future income and expenditure to calculate how much he will be able to borrow for a given period of time. If a borrower’s income and expenses do not support a guaranteed repayment plan, his ability to pay back the loan may come under the scanner.
There are some techniques which lenders employ to evaluate the creditworthiness of individuals and enterprises. These include looking at the borrower’s credit history, his past record of borrowing, whether he was able to pay back previous loans on time, and so on. Lenders also prefer those borrowers who have maintained a consistent payment pattern and are capable of repaying their loans on time.
On the other hand, there are also some techniques that these lenders employ to evaluate the creditworthiness of a borrower. These may include asking for collateral such as home, car, shares, etc. Moreover, there are some lenders who will ask for a co-signer to co-sign for the loan. A co-signer must have a good credit history and meet a minimum age to qualify. Most importantly, he must have the capacity to repay the loan in time.
Besides evaluating credit worthiness, these lenders may also look at the borrower’s regular monthly or installment payments. They are particularly interested in seeing that the monthly obligations are up to date and are in good standing. In case, the monthly obligations are delinquent, they are more likely to decline the loan application. Loans can be approved or disapproved based on the amount of monthly obligations, late payments, default payments, bankruptcies, foreclosures, and so on.
However, interest rates are also one of the most crucial factors which determine the approval or rejection of a loan application. The monthly payment required for taking out the loan, the interest rate at which the loan is taken, the duration of which it is taken, and the term of repayment are all important factors which decide whether the loan will be approved or not. There are certain types of loans such as business debt consolidation loans that have much lower interest rates compared to other types of loans.