Why a Credit Check is necessary even for small loans
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Why a Credit Check is necessary even for small loans

Credit verification of the client is the very first thing any lender does before approving a fresh loan or borrowing

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Why a Credit Check is necessary even for small loans

Introduction

Credit verification of the client is the very first thing any lender does before approving a fresh loan or borrowing. It is the preliminary check that helps the lender to ascertain the creditworthiness of the applicant and helps in deciding whether or not to approve the loan. The need for verification should not depend upon the size of the loan that is being approved. It is prudent to undertake aggressive credit checks even for small loans or borrowing. Credit checks play a crucial role in ensuring timely repayment of the loan and helps in the avoidance of irregularities.

What qualifies as a credit check

Intense scrutiny of a client's credit history is known as a credit check or credit verification. A client's credit history comprises of a detailed record of his entire credit transactions and any financial dealing in which the client accepted some form of debt. This credit history shows all payments that were made over past borrowings and clarifies whether the payments were made regularly or not. The information gathered during a comprehensive credit check includes names of lenders from whom the client had taken money in the past, types of loans or credit taken by the client, payment history, and so on.

How to undertake a comprehensive credit check

To conduct a comprehensive credit check, a lender must gather complete information on the following and also collect documentation to support that information.

1. A lender must ask the client to present his complete payment history of all his previous loans and borrowings, including the number and severity of late payments if any. Credit card history is also a crucial detail to follow up on.

2. Lenders should take a hard look at the debt-to-income ratio of the client to compare the total amount owed by the client to his total earnings each month. Lenders should seek out clients with an ideal debt-to-income ratio. This will help the lender to gain a better understanding of the client's spending habits. A client living beyond his means is likely to falter during loan repayments.

3. The client should be asked to share the number and types of credit he has taken before. Lenders should know how old these debts are and how long was the duration of those credits.

4. Lenders must have an idea about the combined outstanding debt of the client at the time of approving the fresh loan.

5. Lenders must be aware of any information about the client that is part of the public record like bankruptcy or liquidation.

6. Additionally, the number of credit accounts opened recently by the client must also be in the knowledge of the lender.

The utility of a comprehensive credit check

1. The willingness of the client to pay back

The very first thing that becomes clear by assessing the credit history of a client is how sincere the client is towards repaying his debt. The willingness of a client to follow through on the loan obligation is reflected in a credit file free of irregularities. A lender must avoid approving a fresh loan to a client whose credit file is filled with missed or delayed payments.

2. Debt management of client

The credit history of a client demonstrates how the client has managed his debt so far. The number of loans and the amount of each loan being handled by a client might differ on a case by case basis. However, what should be taken into consideration is how the client has juggled his payments across multiple loans or borrowing. If the verification exhibits that the client has been responsible enough to pay past loans or borrowings on time, then the client could be provided with a fresh loan.

3. A standardized way of avoiding NPA

In general, most lenders are looking for decent payment history, with a lower amount of credit and no irregularities while repayment. This serves as a standardized template that all lenders follow to avoid giving out loans that turn into non-performing assets(NPA) or loans that are not repaid on time. Such loans incur losses for the lender and therefore, make the use of credit check quite material to the lender.

Conclusion

The responsibility of the client towards repayment of his debt is the predominant factor affecting his ability to repay a loan. A lender should, therefore, pay attention to the credit report of a client. A lender should be perceptive enough to read all the warning signs in time before approving a fresh loan.

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This article has not been reviewed by Odyssey HQ and solely reflects the ideas and opinions of the creator.
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