Credit risk assessment is needed when taking a personal loan; this is because you can never tell when life will throw you outside the bar. There would be situations you will need emergency funds; situations where your current cash levels are not sufficient enough to cover the need at hand.
This could include the money that is needed for marriage or medical expenses, making a large purchase, or meeting up any other expense for which you lack the needed funds. At times like these, borrowing poses to be the best option.
While there are a various options of loan to choose from, read through to discover why a personal loan is ideal.
Credit Risk Assessment in Personal Lending: What You Need to Know
In a case where there is need for quick cash, going for a personal loan would become ideal, considering how this option boasts of the quickest disbursal compared to other loans in the market.
Don’t forget that, before the lender sanctions a loan, credit risk assessments come into the picture. Let’s explain in details what credit risk assessment is and the top factors that affect credit risk in personal lending.
Credit Risk: What is it all about?
In a nutshell, credit risk is simply the risk of loss that a lender faces due to a borrower’s in ability to repay any type of loan or debt. In the personal lending space, the practice of credit risk assessment deals with ascertaining whether or not an individual should be awarded a certain amount of credit.
This process covers the risk that the lending party will have to bear in cases where the principal and interest of the loan amount will not be received.
Credit risk assessment entails analyzing the bank’s capital and loan reserves at a time, in a bid to mitigate the losses that arise from bad loans.
With regulators demanding more transparency, the task is on the banks to do a thorough background check of their customers and correctly arrive at the associated credit risk.
When it comes to personal lending, the challenge lies in assessing whether an individual will honor the agreement of repaying the borrowed amount or not. The factors to be considered here are; loan amount, payment schedule and tenure of the loan.
In as much as giving people better access to credit can prove to be beneficial to the economy as a whole, it is still important to assess the credit risk involved. Credit assets ends up becoming Non Performing Assets when financial institutions fail to perform their due diligence and award loans without a proper credit assessment this will in turn result to major losses to the lending institutions and eventually to the overall economy.
Key Factors Affecting Credit Risk Assessment in Personal Lending..
It’s important to understand the key factors affecting credit risk when evaluating personal loan applications by a lender.
Assessing credit risk helps in the interest rates significantly. In cases where high credit risk is associated with a borrower — higher interest rates are demanded by the lender for the capital that is provided. If the risks assessed are too high, then banks and lending institutions can also choose to decline the loan application.
Credit Risk Assessment Vs Credit Score
Both credit risk and credit score are often used interchangeably because of their similarities as they are both used to measure the borrower’s credibility.
But we will differentiate the two, so as to enable you know what they really are…..
What is a Credit Score?
A credit score can simply be said to be an indicator that shows is customer’s creditworthiness. This numerical score plays a crucial role in the lender’s decision to offer the loan amount. The major thing you need to know here is that when it comes to a personal loan, credit scores not only impact loan approval but also have a bearing on the interest rates.
Credit score is a number that lenders arrive at by analyzing/verifying the customer’s repayment history and other credit details like utilization of credit and tenures of previous debts across different types of loans and lending institutions.
A credit score is a 3-digit number ranging from 200 to 900. The higher the credit score is, the higher will be the financial trustworthiness of that customer.
Any score above 750 is said to be a good credit score and this allows you to secure loans at lower interest rates. Factors like credit history, credit utilization and duration along with miscellaneous factors such as the number of loan applications that have been made in the past, impacts your credit score significantly.
This numerical score helps lenders evaluate the probability of debt repayment on the customer’s part
Difference Between Credit Risk and Credit Score
Similarly, credit risk and credit score are affected by past credit history, the primary difference is that credit risk provides a much broader scope of evaluating a customer’s trustworthiness while credit score narrows it. Credit risk assessment takes into account broad factors as explained above and is thereby, considered to be more comprehensive and provides a better understanding of the borrower’s creditworthiness.
This above explained is the reason why financial institutions now gives much attention to credit risk assessment while screening loan applications. It has also become a prominent decision-making factor for big loans like mortgages.
In many ways, it is paramount to say that credit risk assessments now replaces credit scores when it comes to evaluating the customer’s borrowing and repayment capabilities because of its broadness.
While credit score is still being used as a deciding factor in loan application evaluations, and lending portals now prefer not to just rely on credit scores and are looking to take on a broader approach.