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LFA Conference: Reading Critical Underwriting Documents

When underwriting a small loan, we will need to evaluate a client’s current financial status. Besides application and dialogues with the client, three official documents, credit report, pay stubs and bank statement are usually taken into consideration as an objective and quantitative measurement of the business income.

Credit Report:

Credit report gives MFIs a general idea of the client’s past borrowing behaviours. A credit report consists of 4 components, personal information; tradelines which is categorized into revolving, mortgage and installment accounts; public records in terms of civil judgment, bankruptcy, tax lien, collections and inquiries; and FICO score. It is important to make sure all 4 components are provided to be able to assess the client’s credit history in a more comprehensive manner. The most commonly used websites to pull credit reports from are Credit Karma, Credit Builders Alliance and Annual Credit Report. Potential online resources such as sample dispute letters and Bankitis can be utilized to help clients remove errors.

Things to keep in mind when reading a credit report:

- The credit report gives you the numbers; the client gives you the context. Use the credit report as a framework for questions for the potential client.

- Make sure you can find each account in the Credit Summary within the credit report.

Pay Stubs:

Pay stubs are one of the most critical documents to calculate net monthly income using two methods: YTD Average and Pay Period Gross-Up.

YTD Average:

Is considered to be the most accurate method. It is how much a client has taken home on average over the course of the year.

Monthly Net Income=YTD Net Income/(#of months elapsed through pay period)

=(YTD Gross-YTD Deductions)/(#of months elapsed through pay period)

Pay Period Gross-Up:

Calculates how much would be earned if the same paycheck was earned every pay period. There are 4 kinds of pay period: weekly and bi-weekly, which usually end on a Saturday and are for hourly employees; monthly and bi-monthly, which usually end on last day of month and are for salaried employees.

Monthly Net Income=(Pay Period Net Income/# of days in pay period)*30

                =((PP Gross-PP Deductions)/# of days in day period)*30

Pay period is not explicitly stated on pay stubs. It can be induced either by applying the general pattern listed above or using www.paycheckcity.com.

Bank Statement:

Is used for business sales or global HH cash flow, usually not for expenses. When looking at a bank statement, we should focus on beginning balance, ending balance and average balance. Average balance is the most important; however, most major banks only show average balances for business accounts while most of our potential clients own personal accounts only. It can be calculated using the formula below:

Ave. Balance=(Daily ending balance * # of days+…)/# of days in the period

Another figure that serves as an important measure of affordability is ADB Coverage Ratio.

ADB Coverage Ratio= Average Daily Balance/Monthly Loan Payment

- Diasy Yuan ’17