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If you're looking to facilitate large transactions or credit agreements, ensuring the appropriate verification checks are completed before any lending is vital. Responsible businesses lend money when transactions are approved via a robust affordability check.
Regulators such as the FCA provide guidance for responsible lending and advise businesses on the appropriate assessments required to approve customer transactions. It all comes down to whether the consumer can afford to sustain the relevant payments.
Failure to complete these checks can lead to many problems, both for the lender and the customer. As well as the potential for missed payments and the impact this can have on a customer's credit file, failure to complete the appropriate verification checks can result in reports being filed against your business for irresponsible lending, which could leave you out of pocket.
What's an affordability check?
An affordability check determines whether a potential customer can afford to make repayments to a credit agreement. It's the lender's responsibility to conduct thorough checks on customers to ensure the credit amount and duration of the agreement are feasible in terms of repayments, which is done through an affordability check.
Before setting up a credit agreement, customers will usually be asked questions about their income and household expenses. Additional information is also drawn from a customer's credit file to assess whether the repayments of the agreement are manageable. These checks are also required if a customer opts to extend or refinance an existing credit agreement.
How does an affordability check work?
Affordability checks examine a customer's income and expenditure, measuring these factors against the value of the desired credit agreement.
By doing this, merchants can assess how much income is left over once all bills have been paid, allowing them to determine whether the monthly repayments of the agreement are achievable.
Factors taken into account include:
- How much is earned.
- How much is spent on bills and other regular payments.
- How much is spent on existing credit commitments.
By completing the above checks, you can determine how much income a customer has left once all bills are paid, allowing you to calculate how much they can afford to pay you regularly.
As a lender, you'll be obligated to adhere to a set of guidelines to help protect customers and businesses. Duties of lenders include:
- Performing ongoing affordability assessments for customers.
- Identifying and detecting potentially problematic debt to prevent the customer from falling into arrears.
- Comply with the Consumer Credit Sourcebook (CONC) and the FCA's credit regulations.
Income assessment
As part of affordability checks, customers must provide proof of income. This can include their past three payslips, their latest P60 and sometimes, copies of their bank statements over the last three months.
A tax year overview and several years' worth of audited accounts are usually required for self-employed individuals. Bank statements (for both business and personal use) can also be beneficial.
Finally, income from other sources (such as part-time jobs, child support, etc.) must also be considered to accurately represent the individual's financial capabilities.
Outgoings assessment
Once a customer's income has been assessed, their outgoings will be considered. Lenders must ensure that the customer's outgoings aren't at a level where an additional credit agreement would cause them financial hardship.
Customers will typically be asked to provide details of how much they spend each month on bills ranging from utilities to mobile phone bills. Additionally, customers will be required to give information on any outstanding credit agreements such as credit cards, car finance or loans.
Credit check
As well as assessing the income and outgoings of an individual, an affordability check also requires a credit check.
A credit check assesses the individual's credit score, helping businesses determine how much risk is involved in the lending process. Typically, those with high credit scores secure deals easier than those with lower credit scores as they are deemed less risky.
What is irresponsible lending?
If a business hasn't done its proper due diligence and completed the necessary affordability checks, customers may end up paying an amount they cannot afford. Not completing the appropriate affordability checks puts the business at risk of being labelled an irresponsible lender, and the customer may raise a complaint.
In the case of a complaint being raised, numerous issues can arise for businesses. According to StepChange, some instances of irresponsible lending have resulted in the company having to refund the interest on a credit agreement or write off debts entirely.
Interbacs affordability checks
Businesses that wish to facilitate large purchases or credit agreements with their customers should be aware of affordability checks and their importance in responsible lending.
Our affordability solutions enable our clients to make a more informed decision on an application, giving your business visibility over a customer's capacity to make repayments and manage their credit.
To learn more about affordability checks and how our services can help protect your business and customers, take a look at our free payment fraud playbook. It contains all the information you need on different verification solutions and how they can benefit your business.
