What is Loan Affordability?
How is “Affordability” Calculated by Lenders For a Loan?
When taking out a loan there are two (2) parties involved, the borrowers, and the lenders. For some loans, which we will see later, a third party, a guarantor, may be involved.
Also when taking out a loan, there are many factors and criteria that both a lender and borrower may use in deciding who to make a loan application with, and for lenders, what factors are used to determine if a loan will be approved or denied.
As a borrower, we need to research and sift through the many lenders out there to decide which bank or loan company best suits our needs.
Comparison web sites have made this easier for us, as they do much of the research upfront, and then present it to us in a nice easy to understand format, even for loans.
Banks and lenders have their own set of rules or criteria to determine who gets approved for a loan, and how much of a loan they get approved for, and for most lenders that criteria or the factors that influence who gets approved for a loan can be broken down into just a couple of categories:
* Credit score: What is your credit score? A high credit core is good, while a low credit score is not so good.
* Affordability : How much can you afford to repay each month in the form of payments? This is usually done via an income and expense sheet outlining all your income against all your monthly bills and expenses.
As we will see, not all lenders base granting loans on credit scores, so that even someone with a low credit score or bad credit, can still be approved for a loan, however, affordability as a factor to get a loan does not go away.
For many banks and lenders, credit scoring is a huge factor in approving or rejecting a loan.
Many lenders have their own set of guidelines for what credit scores are acceptable and what are not for receiving approval for a loan.
If your credit score does not meet the lenders requirements, in some instances all the affordability in the world is not going to get you approved for a loan.
Credit scores are made up of five (5) factors:
* Payment history
* Balances on your existing accounts
* How long you have been receiving credit
* The types of accounts you have
* How often you apply for new credit
Some people through no fault of their own may have a low credit score as they are not credit active.
Others may have a low credit score due to financial issues in the past, they may have missed a few payments on a loan, or defaulted on a loan in the past.
For some loans with some lenders, a low credit score is the kiss of death when trying to get approved for a loan.
What is Affordability?
In discussing affordability for a loan, it is not just how much of a loan you can be approved for, but can you afford to repay the loan, regardless of the loan amount.
In some instances, yes, what you can afford to repay will dictate the amount of a loan you can receive, but overall, you need to show you can afford to repay the loan.
How this affordability is assessed is via an income an expenditure form, which lists all your household income, wages, tax credits, benefits, investment income, any and all income you have.
The form also has you list all your monthly bills, obligations, other loans, credit cad payments, all your monthly expenses and outgoings.
The remaining balance is considered surplus income, and what can be used to determine if you can afford to repay the loan.
For some long-term loans such as a mortgage, or a loan with a longer term that 12 months, lenders need to get a picture a quick snapshot of your finances, and project them ahead to the future to see if you can continue to afford the loan for years to come.
This is not an exact science as you can imagine.
If you are applying for a loan which has a monthly payment of £150 a month, a lender is going to want to see £150 surplus income after your current expenses to verify you can afford the loan. This is £150 at a minimum.
Lenders are not going to see you cut your finances so fine the slightest change in your income or expense will trip a problem in payments.
Lenders may have different rules or criteria they use in determining affordability.
Some lenders may want to see you have a surplus of income that shows you can afford the loan repayments, plus an additional 10%. Each lender can have a different set of affordability rules, and it can also depend on the type of loan you may be seeking out.
Loans That Are Not Based on Credit Scores
As mentioned earlier on, not all lenders use credit scoring as a basis to grant a loan, but they do use affordability.
The bottom line is, you need to be able to afford to repay the loan, period.
Loans such as payday loans, guarantor loans, logbook loans, are not based on credit scores, but on affordability and other factors.
Payday loan are based on the fact you have a job/wages, a bank account, and affordability.
Logbook loans are based on the fact you have a vehicle of value, and affordability.
Guarantor loans are based on the fact you have a guarantor, and affordability.
Affordability is and always will be, a huge deciding factor as to if a loan will be approved or denied.
Prior to making a loan application, it is wise to complete an income and expense form on your own, so you can verify and confirm your own affordability prior to submitting these figures to a lender.
You can also use eligibility checkers as well to see if you may or may not be approved for a loan, all without impacting your credit score.