There are some important differences between the two processes. An affordability assessment, for example, is based on a questionnaire you will be asked to complete and evidence you will be asked to provide. A credit report, on the other hand, is based on information held on you independently by what is known as a credit rating agency.
The different checks have different purposes, too. A credit report is mainly aimed at telling the loan provider how good a customer you are likely to be, or whether there is anything in your credit history that should concern them. It is a general evaluation about how you use credit, and generates your credit score. An affordability assessment, on the other hand, judges whether a particular product - a credit card, a loan, a mortgage - is suitable and affordable for your current circumstances.
A credit report is used by a loan provider to protect its own interests. An affordability assessment is supposed to protect your interests as a customer, by ensuring you don’t take out loans that could get you in financial hot water. Affordability assessments are also mandatory for all officially registered lenders.
Why do lenders carry out affordability assessments?
The UK’s financial watchdog, the FCA, requires all financial companies to follow a set of rules it calls responsible lending. Under the rules, lenders have to make sure they are completely open and transparent about all the terms and conditions of loans they provide, and they have to have steps in place to help customers if they struggle to meet repayments.
The rules also require loan providers to make sure that any loan is affordable and sustainable for the customer. By sustainable, they mean that the repayments will continue to be affordable for the duration of the loan period, not just at first. Lenders can land in big trouble for selling loans to customers who then get into financial hardship trying to pay them back. That’s why loan providers carry out an affordability assessment when you apply.
Why has my loan company stopped lending?
Some loan companies stop trading as soon as the FCA asks to look at how it is meeting its responsible lending obligations. This is because most lenders want to do what’s right by their customers and have no intention of selling loans that put people into financial trouble. If there’s something they can do to tighten up procedures, they are usually more than happy to work with the FCA. It also makes good business sense, because ultimately these companies depend on people being able to pay back their loans. If the FCA can help them change their approach to ensure that happens more often, some see it as a good opportunity.
What happens during an affordability assessment?
The exact questions you’ll be asked as part of an affordability assessment will vary from lender to lender and from product to product. But in general terms, lenders are looking for information about two things:
- Your income, so your wage details, any benefits you receive, income from any businesses you own and from secondary sources like homes you rent out;
- Your living expenses, so monthly bills for things like rent, mortgage repayments, utilities etc, typical outgoings on food, clothing, travel and other essentials, credit card bills and details of any other outstanding loan or finance repayments.
You’ll be asked to provide proof of all of these things, in the form of wage slips, copies of bills, bank balances and other paperwork. The provider will also run a credit reference check to verify any lines of credit you already have.
From all of this information, the lender is trying to establish three things:
- Whether you’ll be able to make the loan repayments on top of your existing expenses.
- Whether you’ll be able to pay off the debt in full during the loan period.
- Whether you’re at risk of having to borrow more or sell assets to keep up with loan repayments.
If, based on the assessment, the lender believes they cannot answer ‘yes’ to all three, they should refuse the loan.
How does an affordability assessment protect me?
However much you think you want or need to borrow, taking out a loan should never put you in financial difficulties or come at the expense of any of your other commitments. An affordability assessment helps you and your loan provider decide whether or not that might be the case.
If you’re turned down for a loan based on an affordability assessment, it doesn’t necessarily mean you shouldn’t borrow. You might want to look at borrowing less, or look at a product with a lower interest rate, perhaps repayable over a longer period.
It’s important to be honest when filling out an affordability questionnaire. Loan providers should ask for evidence to back up what you tell them anyway. But the principle is to keep debt affordable and manageable for you, and that is something anyone looking to take out a loan should buy into.