Pay up your debts, there are new sheriffs in town

From a lender’s perspective, collecting debt from a customer who does not have capacity to pay or is simply unwilling and not giving debt repayment priority can be an odious task. Lenders and especially banks have suffered losses due to non-performing loans by both individuals and companies.

As much as due diligence and appraisal is normally carried out by banks — by analysing the potential borrowers 5Cs of credit — defaults are still lenders major concerns. The 5Cs of credit are condition, character, capacity, collateral and capital.

Lenders need to know the condition of the industry under which the borrower is operating or plans to operate. Is the industry in maturity, decline or growth stage? What is the level of competition and risk levels, among others? For an individual borrower whose shield is employment, what are the chances of retrenchment in the industry?

Character is pervasive and does not matter whether the borrower is an individual or corporation. For an individual, facts which require consideration include the number of residential places an individual has lived in over a period of time, employment history and duration in various job situations. For both corporations and individuals lenders will consider their past behaviour in regard to loan repayments.

Individuals and corporations alike attempt borrowing even if they are aware the loan will constrict their ability to operate normally. Capacity to pay is measured by various factors including a company’s existing debt level. This is applicable to individuals and corporations alike. Low debt level makes one an attractive borrower.

In some quarters lenders emphasise that the amount of mortgage repayment should be not more than one third of one’s net income.

The idea behind this is to leave an individual will a comfortable amount of disposable income to also take care of emergencies when they arise.

To cover themselves against any future default on loan repayments, lenders require security — collateral — by way of personal guarantees or property they can liquidate to recover the owed amount. Both physical, for instance, land and financial assets, for example, shares or bonds can act as collateral.

Capital just other factors is applicable to both individuals and companies. This is the borrowers net worth — what truly belongs to you less what you owe. One may have assets of high value but on the other hand, may owe just as much, making their net worth almost nil.

The 5Cs are an important measure, but credit history and hence a borrower’s credit rating is crucial both to the lender and the borrower.

It is worthwhile for an individual or business to do all they can to boost their credit rating. One’s credit rating determines the interest rate at which their loans will be advanced as well as whether one gets a loan or not.

In many parts of the world two individuals with more or less identical financial needs and almost similar capacity may get financing at extremely different interest rates. This is determined by credit ratings.

In Kenya, the two known credit agencies are Credit Reference Bureau Africa and Metropol Credit Reference Bureau Ltd. For a long time, the concept of credit referencing was unknown to most Kenyans and the role they play in one’s financial journey is still oblivious to a majority.

The concept is now with us and it is upon us to ensure we benefit from the services. The agencies get information about borrowers from lenders and other financial institutions with whom you transact business.

Information which includes the number and type of accounts you hold, the number and level of debt instruments, information about your credit cards, their limits and your repayment history and any relevant public information about you. This forms the basis of your rating.

The credit score is a dynamic history and is updated every time there is a relevant financial activity by you, or a lender upon you applying for a credit facility. Individuals and corporations should check their credit history to know their score and also to ascertain the accuracy in the report.

It is worth noting that bureaus do have varying scoring models, and you may get three different ratings if you request scores from three of them, but still the classification as to bad, poor, fair and good portray similar results about one’s financial strength in regard to lending.

If you have negative information on your credit report, you should immediately start working on improving it by paying your bills when they are due and keep balances on credit cards low.

Also, in case of any unforeseen circumstances like abrupt drop in revenue or loss of job, it is advisable to contact lenders with a view to agree on rescheduling of payments. This way, any potential default which will negatively impact on your credit history will be averted.

Credit history is not used only by financial institutions. Depending on one’s profession or where they intend to seek employment, it is should be cognisant upon them that some employers will require not only one’s criminal record but also their credit history.

Good credit history is a requirement for employment in most financial institutions. For the argument is, how well will you take care of other people’s finances when you can’t take care of your own?

From the lenders perspective and this works more so in developed countries where a majority depend credit cards for transactions, the credit reports create “fear factor” in borrowers that their rating may be messed up and hence jeopardise their future borrowing ability.

The result is that individuals and businesses become self-regulated, pay promptly and in so doing, help lenders reduce remarkably, default rates.

Credit reference bureaus are here and hiding grounds for defaulters are getting fewer.

Mr Were is a business and financial adviser at Anchorage Limited. Email: [email protected]