Loan Grading
Candlefocus EditorThe primary purpose of loan grading is to identify and assign a numerical score, or grade, to assess the risk associated with a loan. This score is factored into the lending institution’s credit decisioning procedure and is usually considered a factor in the underwriting process. Loan grades assess the creditworthiness of the borrower, the quality of the collateral pledged and the likelihood of being able to repay the loan.
The scoring system used for loan grading is typically an automated process. A sophisticated mathematical model is used to assign the numerical digit score to each loan application. This credit score is then compared to the credit quality of other loan applicants and determines the risk in the loan portfolio. Generally, the higher the credit score, the lower the risk.
Loan grading helps assess the risks associated with any given borrower and aids banks and other lenders in determining the potential rewards and risks of extending a loan. It is a useful way to evaluate potential borrowers and determine the chances of repayment over the life of the loan. Additionally, loan grading can also be used to determine the interest rate of a loan. Higher graded loans tend to have lower interest rates and vice versa. Although loan grading is helpful, it should be studied in conjunction with other risk assessment methods, such as a personal, financial, or business analysis. This will ensure that standards are met and that lenders receive their expected returns on a loan.