Question

27) When evaluating a prospective borrower's request for a loan, what are some factors that will affect your determination of an appropriate interest rate for the loan? Describe fully at least four (4) factors

Answer 1

Following factors will be considered while determining interest rate of loan:

1. Credit history - credit history is indicative of your future repayment behaviour, based on your pattern in settling past loans. It helps the bank to know if you will be punctual and regular with your payments. Any default or delay in the past is investigated – the longer the delay, the lower your score is likely to be.

It doesn’t help if you don’t have a credit history as there is no premise to assess, such as no Credit Card or Loan availed in the last two years. However, you can address this by maintaining a Credit Card with no default in repayment.

2. Work experience - Banks weigh your employment history and current engagement to ensure that your source of income is reliable. A bank wants to be certain that your employer is financially sound, with no history of outstanding or delay in paying employees their salaries. Stability of your job matters too. Therefore, government jobs have the added advantage of being perceived as safe compared to lesser known private companies or self-employment.

3. Age - Your age matters because it is indicative of your financially stability. You start working in your 20s and by the time you turn 30 you would have five or six years of work experience. So you are financially stable and moving up the proverbial corporate ladder with a better salary. As you progress further in the next 20 or 30-odd years you will have fewer earning years to repay your loans.

4. Income -  As already mentioned, your income represents your repayment capacity. Banks assess your income capacity in the backdrop of existing debt obligations, dependents, source, and duration. In this context, one of the many things the bank checks is sufficient surplus after EMI payments. If this is found wanting, the bank infers that you’re spread far too thin and likely to default. However, if the ratio is five times and above, the bank will consider you financially healthy.