Ever applied for a loan and had it approved and disbursed almost instantly, or tried to apply for a credit card and had your application rejected? If you answered yes to either of these questions, you know that banks approve of some credit applications and reject others. How do they decide which ones to give a nod to? The answer lies in the process of credit appraisal.

What is the Meaning of Credit Appraisal?

Credit appraisal is the process of assessing the financial status and creditworthiness of any person or entity that has applied for a credit facility. Banks and financial institutions use credit appraisal techniques to understand how risky a borrower may be. The higher the risk, the lower the chances of a loan or credit card application being approved. 

To evaluate the credit risk involved, banks and lending institutions look into various factors that offer insights into a borrower’s creditworthiness. They look into the income level, repayment history and existing debt levels. The credit score is another pivotal aspect of the credit appraisal process.

The Credit Appraisal Process

Before you apply for a credit facility, it helps to understand how lenders evaluate your creditworthiness. So, check out the steps typically involved in the credit appraisal process.

Step 1: Application Processing  

The process begins with the bank processing the application submitted by the individual or entity that requires credit. All the information in the application is assessed and scrutinised.

Step 2: Documentation 

The borrower must also submit other documents required by the lender. They include bank statements, proof of income, identity proofs and the like. 

Step 3: Credit Assessment 

The lender then investigates the borrower’s credit history, financial stability and existing debts, if any. This will give them a clear picture of the borrower’s credit situation. 

Step 4: Financial and Risk Assessment 

Thereafter, the lender evaluates the borrower’s financial stability and repayment capacity. They will also look into the borrower's credit risk level. 

Step 5: Loan Structuring 

If the appraisal of the borrower’s creditworthiness, financial situation and risk is positive, the lender decides the terms of the loan such as the amount, interest rate and repayment tenure.

Step 6: Approval and Administration 

The lender then approves the loan application and disburses the amount to the borrower. Thereafter, the financial institution must administer the loan and update the records regularly. 

Eligibility for Credit Appraisal

The eligibility criteria for credit appraisal depends on the individual or entity applying for a loan. For individual applicants, the criteria assessed include the following:

• Income Stability: Your income level, stability of employment and general financial situation determine your eligibility for the credit facility you need. 

• Credit History: Lenders also look into your credit history as a part of the credit appraisal process. A good credit history increases your chances of being approved. 

• Loan-to-Cost Ratio: This ratio compares the loan amount with the cost of the end goal for which the funds will be used. It helps lenders decide on the amount of loan that can be granted. 

• Debt-to-Income Ratio: This ratio compares the borrower’s existing debts and their current income. The lower the ratio, the lower the current debts, meaning the higher the repayment capacity. 

• Collateral: In the case of secured borrowings, lenders also assess the amount or value of the collateral offered before completing the credit appraisal process.

Why is Credit Appraisal Important?

Credit appraisal techniques are important for various reasons. They primarily help the lender assess the borrower’s repayment capacity and determine the terms and structure of loans and other credit facilities. The key benefits of credit appraisal include the following:

• It helps the lender conduct an effective risk analysis of the borrower
• It establishes the creditworthiness of the borrower
• It promotes confidence among banks and other lending institutions about the borrower’s repayment capacity 
• It is crucial in determining the loan amount and interest rates

Summing Up

This concludes the fundamentals of the credit appraisal process. If you are applying for a loan or any other credit facility, the lender will certainly look into your creditworthiness. Now that you know what the process involves and why it’s essential, you can better prepare for this evaluation. 

Get to Know Your Credit Score Before You Apply for a Loan

Your credit score is one of the most important metrics assessed during a credit appraisal. With Fi's AI-powered Analyser, checking your credit score is quick and easy. The Insights Hub on our Analyser can help you know your credit score. Fi also provides thoughtful, non-intrusive nudges to help you maximise your savings/investments. This is why over 3 million people trust Fi to get a 360-degree view of their money. 

Frequently Asked Questions

1. What is the credit appraisal process, and how does it evaluate an individual's or a company's creditworthiness?

The credit appraisal process is a technique used by lenders to evaluate the creditworthiness of loan applicants. To do this, lenders assess the applicant’s financial status, credit history and credit score, among other aspects. 

2. What are the key eligibility criteria that lenders consider during the credit appraisal process?

The eligibility criteria considered in credit appraisal techniques depend on the type of applicant. Commonly, lenders look into the income level, employment history and stability, existing debts and credit score to gauge the repayment capacity of the applicant. 

3. How does a positive credit appraisal benefit borrowers in terms of accessing loans and credit facilities?

A positive outcome in credit appraisal improves the borrower’s chances of loan approval. It may also lead to other benefits like preferential interest rates, favourable repayment terms and easier access to credit overall. 

4. Can you explain the role of credit scores in the credit appraisal process and how they impact loan approvals?

Credit scores play a critical role in the credit appraisal process because they help quantify the credit risk involved. A high credit score can mean easier loan approvals and more favourable borrowing terms, while a low score can limit eligibility for credit facilities. 

5. Are there any specific factors or documentation that applicants should prepare for a successful credit appraisal?

For a successful credit appraisal, you may need to have documents like your financial statements, proof of income, government-issued identity proof and credit reports ready.