Have you ever approached a lender for a loan or a mortgage? Well, before lenders approve your loan application, they conduct a thorough inspection of your finances and repayment patterns to assess how likely you are to repay the loan, and if you present any risks. This process is called a credit review.
Lenders conduct a credit review when you apply for loans involving large sums of money, such as home loans, car loans, business loans, or home equity loans.
During your application process, you have to provide several personal and financial documents to prove your financial stability. These include your recent tax returns, income proof, account statements, credit card statements, additional debt records, and proof of any foreclosures. Your lender uses this extensive information to figure out whether or not they should lend you money.
How a Credit Review Works
A credit review helps the lender understand whether or not you will be able to pay back the loan amount you are applying for. To begin a credit review, your lender runs an inquiry on your credit report by a credit bureau organisation (such as CIBIL) so that they can access all the data related to your borrowing and credit management history.
Along with the credit report, lenders will also consider numerous other attributes. They are summarised in the table below:
|Income||All sources of income. These will be used to calculate your debt to income ratio or DTI ratio. These include your day job, part-time jobs, or any side-jobs you may have.|
Ideally, a low debt to income ratio is preferred. You must try to keep this under 40%. The lower your debt to income ratio, the higher your capacity to manage and repay a new loan or line of credit.
|Capital||Capital includes your savings account balance, investment accounts like fixed deposits and PPF, and other assets. This lets them evaluate if you have backup financial reserves to use as a safety net for tough times, like job loss or emergencies.|
|Collateral||If you have taken a secured loan, you might have offered something as collateral. This can be a deposit account, land, gold, or property. Secured loans and their respective collaterals are also a part of your credit review. If you fail to pay your loan, your bank or lender can seize the collateral.|
|Stability||While employment and income stability does not seem like a huge factor to consider, many lenders believe that they play a vital role in reducing the risk of lending. A candidate with a stable, high-paying job in an MNC is likely to make enough money and pay off the loan timely.|
|Other debts||Lenders will ask you if there are any other debts which are not shown on your credit report. For example, these can include unpaid medical bills, private loans from family members, etc. These amounts are considered debt and are used to calculate your debt to income ratio.|
Types of Credit Reviews
Your credit review may be conducted in any one of these three scenarios:
Case 1: When you apply for a loan, your lender will conduct a credit review.
Case 2: Your credit issuer may conduct periodic credit reviews
Case 3: You can conduct an informal assessments of your own credit
Let us examine each of these scenarios:
Case 1: When you apply for credit
These reviews are carried out to assess the risks involved with lending you money. So, your lender will ask for a credit review if you apply for a large home loan, car loan, or loan against property.
Case 2: Periodic credit reviews by credit issuers
Credit issuing companies also conduct regular credit reviews of their existing customers. Suppose you have a credit card and you use it frequently. Your credit card issuing company or bank will review your borrowing and repayment history at regular intervals, such as monthly or annually.
The goal of this type of credit review is to ensure that the credit or loans issued are aligned with the company’s standards and that its customers are worthy candidates for credit. So, if your creditworthiness is found to be declined, your company may even cease to provide you services.
Case 3: Borrowers can review their own credit
You can conduct a credit review for yourself if you want to get an idea about your own finances! This is an excellent way to stay on top of your financial health and make steady improvements. It is recommended that you review your credit periodically, identify any gaps, and make positive changes by adopting healthy credit habits or working with a professional.
Is a credit review the same as a credit report?
No! A credit review is not the same as a credit report.
While lenders do evaluate your credit report as part of your credit review, the report itself does not provide sufficient information about your current level creditworthiness.
Here are the key ways in which a credit review differs from a credit report:
- A credit report is a record of your loan repayment and credit management history, but a credit review looks at your current financial situation. This means that your lender wants to understand your current spending and repayment behaviour, not just your past records.
- A credit review includes other information like your income, debt to income ratio, capital, job and income stability, collateral etc.
How does a credit review affect credit score?
When lenders conduct a credit review, they access your credit report. They reach out to your credit bureau (such as Experian or CIBIL) to retrieve your credit report. This process is known as a credit inquiry.
There is a difference between a lender making a credit inquiry for you and you making a self-inquiry. When the lender accesses your report, it shows up as a hard inquiry. While a hard inquiry does not harm your credit score, a series of hard inquiries can affect it negatively. This is why it is best to not apply for too many loans and credit cards at the same time.
However, when you make a self-inquiry, it does not count as a hard inquiry.
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