This site is partly about understanding the psychology of your decision making, but it’s also about mechanics of personal finance.
So as part of the education process, it’s time to think about the process of getting a loan.
Whether you like it or not most of us will at some point think about approaching a financial institution for a loan. This could be anything from a car loan to a mortgage to a student loan. So it’s something that’s likely to you a variety of moments in your life.
Obviously, it’s not as easy as simply filling out a form and then being handed the money. Different financial services companies have different criteria for deciding on whether or not to give us a loan. But if you want to keep in mind a simple, high-level template, think along the lines of the “Four Cs” that lenders often consider as part of their decision-making process:
‘Capacity’ looks at your present and future ability to meet your payment obligation. At the end of the day, the money you’ve borrowed has to be paid back. They won’t be handing out the easy money to those with champagne tastes and beer money.
So if you’re not working, are about to retire or you already have a huge amount of outstanding debt, it will likely have a bearing on your ability to get that loan.
‘Capital’ is all about the value of your assets and your net worth. Essentially, we’re talking about your personal balance sheet of what you own and what you owe. You may not have much money coming in at the moment but the impact of that can be mitigated by the fact that you’ve a fair bit of cash to fall back on.
And lenders have to think in terms of worst-case scenarios. So even if your income situation isn’t healthy at the moment, do you have any assets that are throwing off cash that can help to cover your obligations if required?
This principle dovetails nicely with something highlighted by us: financial integrity. You could have all the personal financial education in the world but if you don’t act responsibly with this information then it’s wasted.
Many people don’t think enough about their payment histories. Your reliability in paying debts (and bills in general) plays a big role in your creditworthiness. It impacts whether or not a lender will be willing to lend, how much they’ll be willing to lend and how much it will cost you to borrow.
Think about it on a personal level. If a friend lends you money but you take far longer than promised to pay it back, why would they rush to lend you money again?
From a lender’s perspective, if you’ve had a checkered past in keeping up to date with payments on a car loan, why should they think that you would be any different with a personal loan you want to take out? Your financial integrity covers both your willingness and your ability to pay back money.
In a variety of situations (for example, if you’re a business owner with inconsistent revenues, you have poor credit or you’re a business startup), lenders will only be willing to lend you money if you have property or assets to act as security.
From a lender’s perspective, this setup tends to work out well because they can lower their risk by having a claim on your assets if you don’t pay up. It can also work well for you by giving you access to loans that you may not otherwise have accessed. That said, if can’t pay the loan back then that’s another story…
Hopefully, these concepts will be a guide.
But don’t go into a bank spouting the “Four Cs” expecting them to apply the principle to the letter (and I don’t just mean the letter “C”…). No, each and every bank will have their own official lending standards and criteria which on the surface may not look anything like the above.
Still, if you keep the “Four Cs” in mind, and you consciously work to approach the system with respect, you’ll be better placed to get that loan on decent payment terms.