The process of taking out a line of credit is changing. In the past lenders were focused heavily on a consumers credit score and their current performance against existing financial commitments – which didn’t necessarily take into consideration the consumers ability to afford the new credit commitment.
Inevitably, this sometimes led to a new financial commitment that could not be repaid or restructured to anyone’s satisfaction. In addition, this could be bad for both the lender and the customer.
Thankfully, lenders are now focusing more on ‘affordability’ – ensuring the customer can manage the product that’s being offered – across the lifecycle of the credit.
The benefits are two-fold:
- The customer gets the loan they can afford without any detrimental effect on their financial status
- The lender minimises repayment issues or the risk of a debt going bad
So, how do affordability checks work?
There are several mechanisms for applying affordability checks and each has a specific part to play in the full credit lifecycle:
- Income verification
- Income estimation
- Understanding a consumer’s estimated disposable income
- Understanding how indebted a consumer is – by comparing income to debt
Information of this kind helps the lender across a range of business functions. At the point of origination, lenders can use an affordability measure to ensure the right limits are placed on an individual borrower.
Within customer management, lenders can ensure that credit limits are not set at a level that would be beyond a customer’s ability to repay, with a keen eye on ongoing risk via debt to income ratios to establish if a customer was drifting towards financial stress. Marketing approaches are also strengthened by ensure existing customers are not targeted for new products that are likely to lead to financial stress.
There will be times when a customer can’t for many reasons meet their financial commitments, with affordability checks being used by lenders to make appropriate arrangements or help to restructure a re-payment plan with terms that are realistic for a customer to maintain.
So, instead of using a system that didn’t look at all of a consumers data and their ability to pay, lenders can now make appropriate and accurate assessments and offer loan terms that a consumer can afford.