I recently read an article by a banking group called Mission Management and Consultants, LLC , who are mortgage bankers and project finance specialists. They work with nonprofits and schools in their financing needs.
According to their article, historically there were four components that bankers and underwriters would look at in determining a borrower’s fitness for a loan:
- Income of the borrower (ability to pay the new loan)
- Equity in the project (how much are they putting down, what % of the project is being financed)
- Stability of the Leadership of the organization (how long has leadership been in place, what is the turnover rate for leadership, etc.)
- Stability of congregation (if a religious organization) or enrollment (if school)
After all that has happened in the economy, the article talked about bankers using a fifth component – Liquidity when looking at credit approval. Liquidity is a measure of cash on hand. Based on their requirements, they like to see at least 4-6 months of operating reserves in place.
Although individuals are not companies or nonprofits, these 5 components are not bad measures for us to use – especially if we are thinking about taking out loans for cars, projects, etc.
- Is our income adequate to service our current debt without that debt being a burden?
- Are we putting enough down on the project? I would never recommend putting 0% down. I think the old rule of at least 20% down is still a good guideline. If you can’t do that, you may want to rethink going ahead.
- How stable is your family situation? Is divorce on the horizon? Are there major changes coming – a new baby, sickness or death of a loved one? These life events need to be factored in.
- How stable is your work environment? Is your industry prone to layoffs? Your company stable?
- Do you have an adequate emergency fund (liquidity)?
Although these are not all the factors, it is a good place to start to evaluate your current financial situation. With these 5 factors in mind, how are you financially?
