Author: Daniel Tan
Written at: 10 Sep, 2023
This blog is a detailed version of what our CEO covered in the Financing Options For Your Business event.
Imagine two loans that are both $300,000 and 5 years long, but one is at 3% and the other is at 3.50% per annum. That would give you a total interest of $45,000 versus $52,500 - a difference of $7,500! While it is very important to compare around (compare easily using our marketplace!) and not pay more than you have to, finding out how to improve your credit profile and when and what loan type to go for, can also go a long way in helping you save on the interest you would have to pay.
When determining if you are eligible for a loan or at what quantum or interest rate, lenders look at these 5 things in a nutshell:
- Character
- Capacity
- Capital
- Collateral
- Conditions
Let's go a little deeper into each of them.
Character refers to the borrower's reputation, integrity, and credit history. Lenders assess the borrower's track record of meeting financial obligations, including previous loan repayments and credit history. A positive credit history and a strong reputation for financial responsibility increase the borrower's character assessment. (Please also see Debt serving ratio for more.)
Therefore, it is also very important to check your credit report from time to time. A lot of business owners or consumers wait until they want to get a loan then they try to download their credit report, only to notice a credit card bill or phone bill they have not paid.
Sometimes, these things may happen simply due to clerical errors. At times, you might have really forgotten to pay and as it was a few years ago, you think nothing of it. But sometimes, even after you pay, the telco or banks may overlook lifting it from your record.
In countries such as Singapore, where business owners are typically required to be guarantors, they would look at the character of both the company and its business owners and request some documentation from both.
Capacity represents the borrower's ability to repay the loan. Lenders evaluate the borrower's income, cash flow, and financial stability to determine if they have the capacity to make timely loan payments. They may analyze documents like financial statements, tax returns, bank statements, and other relevant income documentation to assess the borrower's capacity.
Many business owners do not follow certain accounting and invoicing standards like creating the 4 statements that go into their financial statements. Or having invoices without due dates which then affects your ability to produce a monthly account receivable statement and that affects the ability of lenders to accurately gauge your capacity. This means they may score you lower and charge you a higher interest or even outright reject your application.
Perhaps this is why some joke that, to borrow money, you first have to prove that you don't need the money. If your capacity is less than ideal, that doesn't mean it's the end. Consider checking out other articles of ours on our FAQ or Glossary page.
Capital refers to the borrower's existing financial resources and assets. Lenders consider the borrower's net worth, savings, investments, and collateral. A borrower with significant capital reserves or valuable assets may be seen as having a greater ability to repay the loan or provide security against the borrowed funds.
In Singapore, a "non-subprime" lender, like a bank, typically won't ask for these upfront. Usually, they make their assessment based on your capacity first. Your personal assets are the last resort for them. That means if you cannot repay the loan, they will have to go after your assets - which means a lot more cost for them for loan recovery. So, if possible, they try not to.
If your character and capacity are less than ideal and you have to try a non-bank for a loan, very often you would need to declare your capital. Work with your financial advisor to do a yearly review and prepare a summary of your policy's cash value, and investment value. So that when you need a non-bank loan, you are able to demonstrate your capacity easily.
Collateral represents the assets or property that a borrower pledges as security for the loan. The lenders will evaluate the quality, value, and marketability of the collateral. If the borrower defaults on the loan, the lender can seize and sell the collateral to recover the funds. Collateral helps mitigate the lender's risk and can positively impact the loan terms and interest rates offered.
That is why for property loans or secured loans, you will see that the interest rates are usually lower. So instead of going for a personal loan or working capital loan when you need the cash flow, if you have collateral such as properties, insurance, stocks and shares, consider going for loans like secured overdrafts or property gear-up loans. You can find out more about these loan types by visiting our Glossary page.
Conditions refer to the external factors that may affect the borrower's ability to repay the loan. Lenders consider the purpose of the loan, market conditions, industry trends, and overall economic environment. They use it to assess the borrower's ability to navigate potential risks and challenges that could impact their ability to repay the loan as per the agreed terms.
Unfortunately, this is a factor that you have very little control over. However, this tells you why you cannot base your loan application decision on recommendations from friends or review websites as conditions are constantly changing and your other 4Cs may also differ from them.
For example, you are in the construction industry and a lender does not think favourably of the industry near term. They may then restrict the total amount of exposure they wish to be exposed to the industry and set a cap on how much their total sales force's customers get approved that month or quarter. Or, they may charge a higher rate for any amount after that cap. Therefore, the only way to know exactly how much you can borrow and at what rate, is to let the lenders inform you directly by applying to them one by one or using FindTheLoan.com to reach multiple lenders at once.
In summary, each of the above 5 factors provides insights into the borrower's likelihood of loan repayment. By evaluating these 5Cs, lenders aim to determine the borrower's creditworthiness, the risk associated with lending to them, and the terms under which the loan will be extended.
Newer banks and lenders are adopting a trend of easy to apply, to attract new customers. Requiring minimal info for your loan application. Because they don’t have all the specifics of your financial situation, they may charge a higher rate to offset potential risks they can’t fully evaluate.
During the talk, our CEO also covered a little on how to compare loans and it is not just about looking for the one with the cheapest rate but other things that lenders may do to make it hard for you to compare apple to apple between one loan with another. You can learn more about it at our FAQs.
In an interest rate environment that is lowering, or your 5Cs have improved, from when you first got your current loan - looking at debt consolidation and refinancing your existing loans could help you with lowering how much you are paying for your monthly loan servicing amount.
If you are a business owner, you might find this article relevant as well. "How Personal Loans Impact Your Ability to Secure Business Loans And Vice Versa"
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