Page 115 - DCOM208_BANKING_THEORY_AND_PRACTICE

Banking Theory and Practice

Notes (c) Homeowner/Tenant: The status of homeowner and tenant plays a definite role in
stability. For obvious reasons, a homeowner has more responsibilities and their
risk of moving away is smaller, as opposed to tenants, known to be less predictable.
Being a homeowner is a positive in term of stability.
(d) Debt Ratio: The debt ratio is the ratio between monthly payments of the debt, including
the new loan, and monthly gross income. The limit of an acceptable debt ratio
differs from banks to banks and the type of credit requested, but normally ranges
between 35% and 50%. The level of acceptability also depends on the first two
criteria (personal credit and stability), but a debt ratio too high can stop a loan from
being accepted, no matter how good the credit or stable the applicant is.
(e) Net Value: The net value is the financial equity of an individual, which are the
personal assets minus the personal debt. The assets taken in consideration by banks
are the verified real estate market value of their home and a portion of personal
investments, where 50% to 80% of their value is considered based on risk level. On
very rare occasions cars and other vehicles are considered assets, as they constantly
devaluate.
The biggest asset is normally the real estate. However, these assets are the least
liquid; selling the house to pay some debt is really the last resort. Therefore, a
decision cannot be based on the net value before the first three criteria. It is more of
an indicator of how deep pocketed the applicant is.

If the person has a good equity on their property, it will weight considerably in the
credit application. Not necessarily because the property can be included as a
guarantee, but great equity always gives someone the possibility of obtaining
additional indebtedness on the mortgage, which will help face financial obligations.
(f) Occupation and Personal Status

(i) Professional Status: The occupation is taken into consideration in a credit
application. Doctors, lawyers, engineers and other professionals will be more
valued than self employed workers, the nature of their work being more
unpredictable, and blue collar workers, because it is more difficult to
turnaround in case of job loss.
(ii) Personal Status: The age of the applicant is the main issue, even though it is
considered discriminatory, the lenders will still take it into consideration.
The chances of default are much higher under 30 years old than 50 years old
and up, considered the most desirable age bracket. Less than 20 years old is the
highest risk.
These points determine the interest rate and the goods that will be taken as collateral. In the case
of personal loan, line of credit or other loan where the decision is based only on the individual
applicant, the rate or the guarantee will fluctuate based on the answer given in the first five
criteria. In the case of credit cards, these criteria will not be as important since the interest rate is
already high, reducing some risk of monetary loss for banks. The same principle applies on a
mortgage or the financing of a vehicle, where collateral can lower the acceptance barrier.
In general, banks are looking for a consistency of payments on the debt, therefore a guarantee of
a good cash flow towards them. The lesser importance of the other criteria reflects a less immediate
guarantee of payment. If we interpret their analysis based on the cash flow, banks are first
looking at the reliability of the payer, next at the regularity of their payments, their payment
capacity, and finally, the bank’s capability to get their missing payments in case of default. If one
criterion is not positively fulfilled, the next, lesser important one will not be taken into
consideration.

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