Creditworthiness and affordability
Credit providers do not give credit to just anybody and want to feel secure that you are able and willing to pay them back. So you will need to show them that you are creditworthy and able to afford the credit.
The credit relationship is one that is based on trust – trust that you can afford and will repay the amount that you borrow. Therefore, when a credit provider reviews your application for credit, it looks at your creditworthiness and affordability to establish that trust.
Credit providers want to be comfortable that the credit they grant will be paid back on time and in full. Therefore, they conduct a credit risk assessment to evaluate potential borrowers. Generally speaking, credit providers make decisions about whether to grant credit and the rates they will charge for the credit based on a review of specific areas of your financial situation. Credit providers will normally consider the following criteria:
- Are you able to pay it back?
This is a measure of your affordability and is your capacity to repay the loan on time. The credit provider will have to validate your gross income and determine whether you will be able to make the payments in terms of the credit for which you applied. If your monthly income varies, for example with overtime or commission, the credit provider will take an average of your income over at least three months (the last three months before you applied). It might also average your income over six months or a year, depending on the individual credit provider’s internal assessment standards.
The credit provider will also look at how stable your employment or income is. It might, therefore, look at how long you have worked for your current employer. Some credit providers even request a letter from your employer. Another consideration in determining your affordability is how much you already owe and whether you will be able to afford the new credit while continuing to make payments on your current debt obligations. So, they need to determine how much your budget allows you to borrow at this time.
- Do you have anything to contribute, for example a deposit? For secured credit, such as vehicle finance or a home loan, a deposit would lower the amount of credit you are taking up and would therefore also lower your credit repayments.
- Do you have an asset to secure your loan?
Collateral is property or an object of value that a credit provider can take and sell in case of default. This would be if you were applying specifically for a secured loan. This would then lower the risk for the credit provider, and you may then be given a lower interest rate.
- Will you pay if you can? Do you repay your debts as agreed?
In determining your creditworthiness, credit providers look at your credit behaviour. Here they will access your credit profile from a credit bureau and will check their own credit records to see whether you have a previous relationship with them. By looking at your past behaviour with credit, they are able to determine the risk you might pose to them.
- What does the economy look like?
The worse the economic conditions in the country, the tighter lending conditions become. This is espe- cially true for companies that want credit, but for an individual it is also true because a poor economy might make it harder for you to repay the credit. Credit providers might also look at the potential for strikes in your industry, which might affect your job and income.
Legislation was introduced in South Africa in 2001 in the form of the Prevention of Organised Crime Act (POCA), the Protection of Constitutional Democracy against Terrorist and Related Activities Act (POC- DATARA), the Prevention and Combating of Corrupt Activities Act, and the Financial Intelligence Centre Act (FICA).
These were designed to combat money laundering, which is the abuse of financial systems in order to hide or disguise the proceeds of crime.
Money laundering, at its simplest, is the act of making money that comes from Source A look like it comes from Source B. In practice, criminals are trying to disguise the origins of money obtained through illegal activities so it looks like it was obtained from legal sources. Otherwise, they cannot use the money because it would connect them to the criminal activity, and law-enforcement officials would seize it.
Apart from criminalising the activities constituting money laundering, South African law also contains a number of control measures aimed at facilitating the detection and investigation of money laundering. These are contained in FICA. These measures are based on three basic principles of money laundering detection and investigation:
- Intermediaries to the financial system must know with whom they are doing business.
- The paper trail of transactions through the financial system must be preserved.
- Possible money laundering transactions must be brought to the attention of investigating authorities.
The control measures introduced by FICA, 2001, require institutions to establish and verify the identities of their clients, to keep certain records, to report certain information and to implement measures that will assist them in complying with the Act.
Some of the documents a credit provider may request to determine creditworthiness and affordability are:
|Documents required to apply for credit||Documents required for credit assessment||Information required|
All credit application forms and contracts should therefore include the above information, of which the documents you provide act as proof, as well as provide for your written consent to perform a credit check. In light of this, the NCA has specific requirements in terms of the informa- tion that must be requested on a credit application form.
Once credit information has been obtained from all the different sourc- es, a credit provider has to verify every bit of information gathered prior to advancing to the next stage of the credit-granting cycle. This import- ant step is to ensure the following:
- Checking that all information has been received
- Identifying any problems that may cause interruption later, for example if you are married in community of property
- Verifying that information from various sources corresponds
- Prevention of fraud
As mentioned previously, the NCA says that credit providers are not permitted to lend to a consumer who is over-indebted. The NCA says that an applicant is over-indebted in terms of the NCA if most of the information at the time that the application is made shows that the consumer is or will be unable to meet all his/her obligations under all credit agreements in terms of:
- His/her financial means, prospects and obligations (affordability)
- The likely chance that he/she will be able to pay it back on time (credit risk or creditworthiness)
During this stage, the credit provider will make sure that all the information it has received is crossreferenced and found in order. Diligence in this regard will ensure that the consumer is not over-indebted and it will prevent reckless lending.
A credit provider has to be able to prove that all the information it received from you is accurate. This is so that you will not be able to claim that credit was reckless if the information provided to the credit provider was actually false. Credit providers may wisely include a statement in the application form that you will sign to declare that information provided on the form is complete and accurate.
The process a credit provider will follow to calculate affordability is shown in the following diagram.
Using the above diagram as a guideline, an example of an affordability calculation would be as follows:
|Affordavility Calculation Example|
|Gross monthly income||R24 000.00|
|Less Staturoty deductiions (eg. UIF, PAYE and maintenance)||R4 133.80|
|Equals Income after deduction||R19 866.20|
|Less Necessary living expenses||R11 638.74|
|Less Other committed payment obligations (including debt)||R3 865.26|
|= Affordability amount||R4 362.20|
Necessary expenses are your minimum living expenses, including maintenance payments if applicable, and excluding monthly debt-repayment obligations in terms of credit agreements. The seven categories of necessary expenses are:
- Water and electricity
The law sets a minimum amount for declared expenses, based on your gross income, that credit providers need to follow to ensure that consumers do not under-declare their expenses.
Things to Note
Where the consumer’s monthly gross income shows material variance, which means the income changes from month to month, the average gross income over the period of not less than three pay periods before the credit application must be used.
All the information gathered during the credit investigation is then weighed against the size of the loan you have applied for and the loan-repayment term. It is also weighed against the risk the credit provider is willing to take to grant you the loan.
Creditworthyness and affordability: FAQ
What is affordability and creditworthiness?
Affordability checks try to answer the question: Can this customer pay back the loan?
That is, does the customer have the financial means to repay the loan every month? The NCA gives all credit providers specific guidelines on how to decide a consumer’s affordability.
Creditworthiness checks need to answer the question: Will this customer pay back the loan? This means looking at your payment history and behaviour to determine whether you are a high-risk or low-risk bor- rower. The lower the risk, the higher your creditworthiness and the higher your chance of getting a loan.
Can I apply for credit by myself if I am married in community of property?
Yes, however, there are rules. If you are married in community of property, your spouse will need to go with you to apply for credit, or must give you written consent to do so. Both of your incomes and credit re- ports will then be used in the credit investigation or credit risk assessment, and both of you are liable for the debt.
What is risk appetite?
Risk appetite is the level of risk an organisation is prepared to accept. For credit providers it is the amount of risk they are willing to accept when granting loans. Different credit providers have different risk appetites and this determines to whom they will and will not grant credit.