How to make sense of your business customers’ loan capacity

Discover how lenders are overcoming the challenge of understanding borrowers’ debt-to-income ratios and existing liabilities.

Understanding a borrower’s loan capacity is the linchpin of any effective underwriting process. This is particularly important in the current economic environment, where many businesses are seeking external financial support. However, our research indicates that cases of loan shopping and loan stacking are more prevalent than you may think, which poses a challenge for lenders looking to establish a comprehensive understanding of a business’s financial situation.

This blog delves into the obstacles lenders face in assessing loan capacity, how this challenge is evolving, and introduces a streamlined solution: Codat’s Loan Report feature.

The significance of debt-to-income ratio

Assessing loan capacity requires a calculation of a borrower’s debt-to-income (DTI) ratio, a fundamental metric in underwriting. It offers lenders insight into the applicant’s ability to take on additional debt, with a lower DTI signaling a better chance of loan qualification, while a higher ratio raises red flags requiring further investigation. 

The calculation of DTI helps lenders accurately determine affordability as well as identify instances of loan shopping and loan stacking, which has become more widespread in the last few years.

To better understand the impact the current economic environment is having on instances of loan shopping and stacking, we surveyed over 300 small and medium-sized businesses in the US and UK. Continue reading to uncover the results.

1. Most businesses that require credit usually apply to multiple lenders

We discovered that 63% of businesses seeking credit applied to multiple lenders, with a surprising 30.5% submitting between 3-5 applications. This indicates that businesses are actively shopping around for credit and exploring multiple options before making a decision. 

2. Over half of businesses requiring credit have held multiple loans simultaneously

We found that 52% of SMBs have held multiple loans at the same time, and 35% of businesses have taken out loans with different lenders. Additionally, almost half (47%) of businesses have taken out multiple loans within the same year, indicating the frequency of financial difficulties faced by them. 

Taken together, this data suggests that it’s more important than ever that lenders have a comprehensive understanding of borrowers’ debt-to-income ratio. There’s just one problem. These insights are incredibly difficult to source.

The complexity of uncovering existing loans

Lenders face significant challenges when it comes to getting an accurate and holistic view of their customers’ existing loans and liabilities. For most lenders, this is only possible through a highly manual process that looks something like this:

An illustrative example of a manual loan identification process.

1. The lender has to manually comb through bank transaction data to identify existing loans. Loans listed under liabilities will be labeled differently making them harder to spot, and may also be misclassified as assets with a negative balance.

2. The lender has to ask borrowers to share pre-prepared debt schedules or to self-declare existing loans. This results in low confidence and trust that the data shared is actually correct. Businesses may embellish the truth to secure more favorable outcomes or unintentionally omit certain liabilities. 

3. The lender relies on an OCR tool or open banking platform to flag loan repayments. The data provided often lacks additional context beyond just the amount and direction of a transaction, including the intention and circumstances surrounding it. This makes it difficult to understand things like interest rates from the breakdown of principal and interest payments.

This drawn-out process introduces several pain points for every stakeholder:

👥 Underwriters spend significant time on administrative tasks, such as chasing applicants for required documentation and manually categorizing payments. They are also expected to understand the context surrounding bank transactions despite being provided with limited information.

🏪 Customers must endure a lengthy, friction-filled application experience—which requires them to gather and prepare their own financial documents for submission—then wait days or even weeks or months for a decision.

🏦 Lenders take on additional risk, potentially providing loans despite missing, incomplete, or inaccurate data, increasing both direct costs and risk. Even in the best-case scenario, insights from OCR tools or open banking platforms only offer a one-dimensional view of a customer’s incoming and outgoing payments.

A streamlined solution: Codat’s Loan Report feature

Lenders can gain real-time insights into applicants’ outstanding loans and repayment history using Codat’s Loan Report feature. This feature not only simplifies the underwriting process but also uncovers repayment behaviors and previously hidden instances of loan stacking using data from their accounting, banking, and commerce systems.

With Codat’s help, lenders can streamline the process from end to end and save time and money on administrative tasks. Here’s how:

1. The customer connects their financial software: Applicants provide access to their financial data from various sources, such as banking, commerce, or accounting platforms, via Codat’s conversion-optimized authorization journey.

2. Codat generates a report of all outstanding loans: Codat employs sophisticated algorithms to automatically identify and categorize financial transactions related to drawdowns, repayments, interest rates, and balances across all existing loans. 

Codat then collates loan obligations together from multiple applications to offer a high-level overview and transaction-level information on potential loan liabilities in a comprehensive loan summary. This summary includes details on outstanding loans, complete repayment history, and other relevant information that underwriters need to assess the applicant’s loan capacity.

3. Lending decision based on more comprehensive data: Lenders use this information to determine the best course of action. With all the necessary data, they can make decisions that match their lending policies and risk tolerance.

4. Ongoing visibility of loan transactions: Codat’s system continuously monitors the connected financial accounts for updates. This ensures that the information provided to lenders is real-time and reflects the most recent financial transactions and activities of the applicant.

The benefits

Take a look at all the ways lenders can benefit from using the Loan Report feature:

🏊‍♀️ Streamlined assessments: Instead of navigating through multiple documents and sources, underwriters can access a consolidated view of a borrower’s existing loans and repayment history across accounting, banking, and commerce systems. This streamlined process accelerates the underwriting timeline, allowing for faster, smarter decision-making.

🚩 Early detection of red flags: The Loan Report aids in the early detection of potential red flags, such as high debt-to-income ratios, a history of missed payments, or potential loan stacking.

💪 Robust risk assessment: Armed with comprehensive and accurate data, underwriters can make decisions that align with the institution’s risk tolerance and lending policies. This informed decision-making contributes to a more robust risk management strategy.

🔍 Enhanced visibility: The Loan Report feature provides underwriters with a comprehensive overview of an applicant’s financial health. It categorizes drawdowns and repayments across all existing loans, offering a clearer picture of a borrower’s financial commitments.

Real-time data: Rather than offering a snapshot in time, lenders access live data, enabling them to make decisions based on the most up-to-date financial information available. This ensures underwriting decisions reflect the current financial situation of the borrower.

💸 Evaluation of repayment behavior: The Loan Report feature offers insights into repayment behavior so underwriters can gauge whether a borrower consistently meets their repayment obligations.

🔄 Consistent data format: Data is presented in a standardized format allowing for easy comparison of information across loan applications. This promotes fairness and uniformity in decision-making.

But don’t just take our word for it. Read what Taktile‘s CEO and Co-Founder had to say about the feature below:

How Codat can help

Understanding a borrower’s existing loans is paramount for any lender. Codat’s Loan Report feature empowers lenders to make efficient and accurate lending decisions. By adopting this technology, senior leaders can enhance their organization’s capacity to offer loans while saving time and resources for all stakeholders involved.

Reach out to Codat’s team using the form below for a closer look at the benefits of the Loan Reports feature.