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There are many factors involved in being approved for credit. However, perhaps one of the most important today is affordability. Changes in the personal finance market over the past decade have put affordability at the top of the list of criteria that lenders must establish before they decide to approve a loan application. But what kind of tests do lenders use to measure affordability and what does it mean for you if you don’t pass them?
The basis of affordability is whether you can borrow the personal loan – or use the credit card that you’re applying for – and be able to make the required repayments. And once you have made the repayments, will you still have enough disposable income to make other essential payments, such as mortgage or rent, the cost of food and transport.
So credit providers will need to know your monthly income (net of taxes) versus your monthly outgoings. They will probably try to distinguish between your discretionary costs (i.e. those things you can choose not to spend money on e.g. your socialising) versus non-discretionary (i.e. those costs you can’t avoid, such as food, energy, rent/mortgage payments & travel, etc).
But don’t get affordability mixed up with creditworthiness. Your creditworthiness needs to be strong too. If you can afford the loan repayments but your repayment behaviour has been poor (as recorded in your credit file at the credit reference agencies) they may still refuse to lend to you. You need to be able to demonstrate that you can afford the loan repayments and that you actually do make the repayments on time and in full.
So credit providers will also use your credit report to help them make a judgement about whether to lend to you. They don’t use the credit scores generated by credit reference agencies but, instead, will use the information in your credit report to generate their own. The following factors will have an influence over how credit providers assess your credit worthiness:
There is now an increased focus on responsible lending, particularly in the short-term credit sector. The UK Financial Conduct Authority has issued official guidance that makes it clear that a credit provider should not be advancing credit to a customer before assessing their creditworthiness (including affordability). This is a requirement in addition to the assessment the credit provider will do to determine the risk to itself in providing the credit to the customer. As a result, every lender will now carry out an affordability assessment so, for those looking to borrow, it is an important factor to consider.
If you find yourself in a position where a credit provider has refused your application on the basis of affordability then there are a number of steps you can take.
Alex Hartley is a keen advocate of improving personal finance skills. She's worked at Solution Loans since 2014 and written hundreds of articles about how people can manage their money better. Her interest in personal finance goes way back to...Read about Alex Hartley
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