Criteria to Evaluate Loans

Loan evaluation is the systematic process of assessing whether a borrower can meet the repayment obligations of a proposed credit facility. It involves analysing the borrower’s financial health, the purpose of the loan, and the security offered, all within the framework of SEBI and RBI guidelines.

For an investment adviser, the evaluation must be objective, documented, and aligned with the client’s risk‑profile. The adviser’s recommendation influences the client’s portfolio construction, making accurate assessment critical for both compliance and client trust.

In the NISM exam, you will often see case‑studies where you must rank or select the most suitable loan based on a set of criteria. Remember that the weightage of each criterion can differ across loan types (personal, home, business), but the core parameters remain constant.

Credit Score – A numeric representation of the borrower’s past repayment behaviour. In India, a score above 750 is considered excellent and carries the highest weight in most loan assessments.

Income Stability – Consistency of earnings over the past 2‑3 years, verified through salary slips, Form 16, or audited financial statements for self‑employed clients. Lenders prefer salaried individuals with a minimum of 12 months of continuous employment.

Purpose of Loan – The intended use (home purchase, business expansion, education) must be legitimate and align with the client’s overall financial plan. Mis‑matched purpose can lead to higher risk perception.

Quantitative ratios convert raw financial data into comparable metrics. The most common for loan evaluation is the Debt Service Coverage Ratio (DSCR), which measures the borrower’s ability to service debt from operating income.

Another useful metric is the Loan‑to‑Value (LTV) ratio, especially for secured loans like mortgages. LTV = (Loan Amount ÷ Appraised Value of Collateral) × 100 %. A lower LTV indicates a safer loan from the lender’s perspective.

Exam questions may ask you to calculate DSCR or interpret an LTV figure. Always keep the units clear – DSCR is a pure number, while LTV is expressed as a percentage.

Interest rate and loan tenure directly affect the Equated Monthly Installment (EMI). Higher rates or longer tenures increase the total interest paid, even if the EMI appears affordable.

Advisers must calculate EMI to gauge repayment capacity. The EMI formula assumes a fixed rate and equal monthly payments, which is the standard assumption in NISM scenario questions.

Remember that a small change in rate (e.g., 0.5 %) can alter the EMI by several hundred rupees for a ₹10 lakh loan, a detail often tested in multiple‑choice questions.

Collateral provides a fallback for the lender if the borrower defaults. In India, common securities include immovable property, fixed deposits, and government securities. The valuation must be recent (within 3 months) and certified by a licensed valuer.

Legal due‑diligence includes verifying title, checking for existing encumbrances, and ensuring proper registration of the charge. SEBI mandates that all loan agreements be in writing, with clear clauses on pre‑payment penalties and foreclosure rights.

Exam items may present a case where the collateral value is lower than the loan amount. In such cases, the adviser should recommend a lower LTV or request additional security.

The credit profile combines the credit score, existing debt obligations, and repayment history. A high credit score reduces perceived risk, while multiple existing EMIs increase the debt‑to‑income (DTI) ratio.

DTI = (Total Monthly Debt Obligations ÷ Gross Monthly Income) × 100 %. A DTI above 40 % is generally considered risky for unsecured loans, whereas secured loans may tolerate up to 50 %.

When the exam provides income and existing loan details, calculate DTI first, then cross‑check with the DSCR to form a holistic view of repayment capacity.

1. Verify KYC and credit score. Ensure the score meets the minimum threshold for the loan type.

2. Calculate DTI and DSCR using the borrower’s income and existing debt. Both ratios should be above the regulatory benchmarks (DTI < 40 % for unsecured, DSCR > 1.2 for most business loans).

3. Assess collateral value and compute LTV. Keep LTV below the maximum allowed for the specific security (typically 90‑95 %).

4. Review loan purpose documentation and ensure it aligns with the client’s overall financial plan.

5. Confirm that the interest rate, tenure, and EMI are affordable given the borrower’s cash‑flow projections.