Definition of the week: AFFORDABILITY Affordability is whether a person or company has enough money to pay for something. In credit, this is understood as whether a person or company can afford to pay back the credit they take out.
In today’s lesson, we will look at the criteria or conditions that a credit provider takes into account when you apply for credit. There are five criteria used to determine your affordability: 1. What is the country’s economy like? 2. Can you pay a deposit? 3. Can you secure your loan with an asset? 4. Can you pay it back? 5. Can you pay on time? Let’s have a look at these in more detail. What is the country’s economy like? If a country’s economy is poor, the lending conditions usually become stricter. A poor economy means that you may not be able to afford to pay your credit instalments. A credit provider will also look at the industry in which you work. Some industries have the potential for strikes, which may cause loss of income or even unemployment. Can you pay a deposit? When you take out secured credit, such as a loan to buy a car or a house, a deposit is sometimes required. A deposit will lower the total amount of credit you borrow, as well as your monthly payments. Can you secure your loan with an asset? For secured credit, providing collateral lowers the risk to the credit provider, who will then normally give you a lower interest rate. Collateral is an asset, such as property or another valuable object, which the credit provider can take from you and sell to cover the cost of your credit, if you default. Can you pay it back? This looks at your affordability and whether you can repay your loan within the given time. The credit provider will look at your gross monthly income to calculate your affordability. If your income changes on a monthly basis, for example because of overtime worked or commission paid, the credit provider will take the average of your income during the last three months. The credit provider also looks at whether your income and employment is stable. This includes how long you have worked for your employer. Sometimes a credit provider might require a confirmation letter from your employer. Another factor is the debt you currently owe. The credit provider needs to calculate whether you can take out new credit and still make regular payments on your current debt. Can you pay on time? Credit providers will look at your credit history and behaviour to determine your creditworthiness, or what the possibility is that you might default. They will contact a credit bureau to check your credit profile, and also check their own records. Looking at your credit history allows a credit provider to determine your risk of not paying on time. Helpful Hint: A credit provider will decide whether you qualify for credit based on your credit history and affordability, as well as their own policies and procedures. As a first step, you can view your full credit history monthly on www.mycreditcheck.co.za for a small fee. Your credit history will help you decide on whether or not you should take out credit. If you’d like to work out your affordability, most banks have this function online! Simply type “affordability calculator + [name of bank]” in the search bar of your browser, and select the calculator that suits you.
Come back next week to learn more about how your credit application gets assessed!