Chapter 3b: Loan Delivery

This chapter walks you through the basics of preparing your organization to deliver loans. Before starting a loan fund, set up systems and processes to receive loan applications, to review applications, to approve and close loans, to accept monthly payments, and to manage delinquent accounts. Many emerging loan funds design their own systems. It is also possible to rely on third parties (university, local bank or credit union, another local nonprofit) to host some or all of the systems necessary to begin microlending.

Loan application

The first step to take after a client expresses interest in a loan is to collect some basic information to determine whether the client meets minimal eligibility requirements and you should move forward with underwriting (reviewing the loan application).

Some information you may consider including in your loan application that will help determine 'loan readiness':
  • Loan purpose: Be wary of lending to someone who lacks a clear idea of what she wants to use the money for. We're also wary of lending to someone who has a clear but foolish use in mind.)
  • All monthly income (from a job, business, spouse, other source)
  • Does applicant have checking and savings accounts?
  • How much in liquid assets or savings do they have on hand?
  • Number of cars owned by the household and the year, make and model of each. (Earning little income but owning an expensive car suggests poor money management skills. A car can also be used as collateral.)
  • Number of adults and children in household and average cost of living
  • Monthly housing cost (What share of the applicant's income does it consumer?)
  • Number of years at current residence (Are they stable? Transient?)
  • Have they had a late rent or mortgage payment in the past 12 months? (If the answer is yes, this should signal a red flag. Having lapsed on child support payments is another potential deal-breaker.)

Sample loan applications from US Microlenders:
ACCION Chicago
Business Loans; Avg Loan Size: $6700
Click here for ACCION Chicago Application.pdf
FINANTA
Business loans; Avg Loan Size: $120,000
Click here for Finanta Loan Application.pdf
Greater Newark Enterprise Corporation
MicroLoans from $1000-$50,000
Click here for GNEC Loan Application.pdf
Justine Petersen
Business Loans; Avg Loan Size: $6700
Click here for Justine Peterson Loan Application.pdf
Opportunity Fund
Microloans from $1000-$10,000
Click here for Opportunity Fund Loan Application.pdf

Underwriting

Background

Underwriting is the process of analyzing a loan application and its supporting documents to decide whether to approve or decline a loan. It is an investigation into a person’s financial circumstances and creditworthiness to understand whether a client is likely to benefit from and repay a loan.

Underwriting is the most time-consuming piece of lending. Arguably, it is also the most important piece of lending because the process allows a loan fund to maintain a healthy portfolio and to minimize bad loans. Red flags missed during the underwriting process can lead to problems with repayment.

Groups in early stages often have trouble embracing a thorough underwriting process. They worry about turning away needy applicants and becoming too much like a bank. Ultimately, the objective of microfinance is to help clients build assets and achieve economic self-sufficiency. When a loan is not used properly, however, it just becomes more debt. Although the need may be there, the experience of the microfinance industry has been that credit is often not the most helpful tool for clients experiencing financial difficulty. Good underwriting provides flexibility for applicants in nontraditional circumstances, while mitigating the chance that the loan will overextend the borrower.

Traditionally, lenders use the “5 C’s” to evaluate client characteristics that provide insight into the riskiness of a client as a borrower. The 5 C’s are credit, capacity, character, conditions, and collateral. Each lender determines its own underwriting process. Often there are many people involved in the collection of information, review of facts, and the decision-making.

During the underwriting process you want to figure out if the client 1) client needs the loan 2) can afford the loan and 3) is likely to pay the loan back. Additionally, for business loans you also want to look at the potential loan’s impact on the business and whether the business is likely to succeed.

Information Review

Several documents are necessary to thoroughly review a client’s creditworthiness for your loan product. These documents supplement the loan application to provide a complete picture of the client. It is helpful to collect as much information as possible, review it, and make a decision. Below is an example of pertinent client information to gather and questions to guide the review of this information.

Capacity
Determine whether the client can afford the loan. The acceptance of credit depends upon an objective evaluation of the client’s ability to repay the borrowed funds. In order to ensure the safety of the principal, a substantial and independent source of repayment should be identified. The client must demonstrate capacity to generate sufficient cash flow to repay debt. Throughout the process of verifying this capacity, be very skeptical about income.

income_graph.png
Use these tables to determine capacity

This basic chart above demonstrates how to estimate a client's income and expense for the household and the business. It is very common for microentrepreneurs to mix business and household finances, which is why it is important to look closely at the net profit of the business and disposable income of the household when underwriting business loans.

Information to review and documents to collect:
  • What is the household’s monthly income?
  • What is the business income and expense? How does money come in and out of the business? Cash or check? How can the amounts be verified? (Get creative here since many businesses are small and have informal or nonexistent accounting systems. Sometimes you might be doing forensic accounting to create a profit and loss for businesses that use mostly cash and don't have perfect records.)
  • What is the disposable income?
  • Documents to review: Paystubs, Bank Statements, Tax Returns
  • References to call: Business clients, employers, landlords

Use this sample template (Applicant Income & Expense Worksheet.xls) when interviewing your client to help you determine your client's capacity.

Credit
Your target market will likely have thin credit files or no credit files and therefore what is not on the credit report is often the most important information to gather in underwriting. If the client has a credit file, the credit report is an excellent tool for reviewing an official history of the client’s experience with credit. The credit report will help answer these questions:
  • How much ‘official’ debt (debt reported on the credit report) does the client have?
  • How many open accounts does the client have?
  • Has the client made late payments previously?
  • Has the client experienced a bankruptcy or foreclosure?

The credit report also allows you to quickly determine if the individual meets your minimum credit requirements. It is best practice to identify some clear eligibility criteria related to credit. For example, if the client paid late on his mortgage in the last 12 months, then we cannot consider him for a loan.

Character
Decide if the client is likely to repay the loan. Fundamental to every credit decision is the honesty and integrity of the individuals to whom the fund lends directly or who manage the enterprises to which the affiliate lends. Character is the single most important factor in the credit decision. If at any time the character of the borrower or the use of funds is in question, then credit is not to be extended regardless of how secure the transaction may appear to be.
  • Is the client trustworthy?
  • Is the client communicative and eager to share information?
  • Is the client organized, open, and honest?
  • Review: References, Loan officer’s experience with client

Collateral
Collateral is often an important means of adding assurance of recovery of the loan. The pledge of collateral should be legally sound, properly documented, and continuously reviewed as to its value and marketability. Lenders should only take collateral that retains resale value, like a car. Other suggestions for collateral include UCC Liens. A UCC Lien is collateral against business equipment. If an item has a UCC lien placed on it, the item cannot be sold to another party. For example, a lender could place a UCC lien on a refrigerator to give a loan to a bodega shop. Keep in mind, in order to take an asset as collateral, it must be fully owned and paid for. A piece of machinery or car that is still being financed cannot be used as collateral.
  • What are the client's assets?
  • What happens if the client defaults on the loan? Will we collect on the collateral?
  • What is the process in my state/city for collecting on collateral?

Capital (Cash)
A borrower should provide capital for anticipated adversity. The lender must evaluate its position relative to the borrower's capital structure and value of the underlying assets in liquidation.
  • How much does the client have in liquid assets?

Conditions
The prevailing and future business climate impacts the borrower's ability to repay the loan. Business cycles, the regulatory environment and unforeseen fluctuations in the economy necessitate an awareness of external variables that can affect the normal cash flow of the borrower's business. Each transaction should be considered within the context of its economic setting and the business cycle.
  • Is the business affected by seasonality?
  • What is the current business client for the industry?

Loan Committee Presentation

The loan committee’s role in underwriting is to oversee the risk management of your lending practices. After the underwriter decides whether a loan application is viable, a staff member presents pertinent information to your loan committee and members of the committee vote to make a final decision. If a borrower or loan is declined by the underwriter or loan officer, the loan committee does not receive any information on that loan. It is also not relevant to send all of the documents and information collected to the loan committee. Staff should prepare a loan underwriting summary of 2-3 pages that concisely outlines and argues for the borrower and loan’s viability to send to the loan committee..

Generally, a loan committee is a group of 4-6 individuals who are vested in the success of the loan fund, have some experience with lending, and are responsive. Loan committees can meet in person on a bi weekly or monthly basis to make final decisions on lending or receive documents and submit votes electronically. Some loan committees monitor loan portfolio quality including review of delinquent borrowers in addition to participating in the underwriting process. Other common loan committee responsibilities include: oversight of pricing, procedures and profitability of the lending functions and assuring compliance with applicable laws and regulations.

Example Processes

The best process for your organization to review all of this information depends on the staff and resources you have available. Start with a system and be flexible to adapt as you discover the pieces that aren’t working. See below for examples of how The Intersect Fund and Elmseed Enterprise Fund manages their underwriting.

The Intersect Fund’s loan application and underwriting
The Intersect Fund uses an online application form that can be filled out with a client over the phone or via laptop or ipad at a remote location. After a Loan Officer collects a potential borrowers’ information, the Underwriter pulls the credit report and determines whether the borrower has been pre-approved. If so, the Loan Officer asks the borrower for copies of supplemental information (4 references, bank statements, verification of identification, paystubs, tax returns). An Underwriter reviews the loan application + supplemental documents. The Underwriter calls references. The Underwriter reviews all the information to decide whether the client can afford the loan and whether the client is likely to repay the loan. The Underwriter writes up a summary of her decision and sends it to the Loan Committee. The Loan Committee votes to approve or deny the loan. If 3 or more committee members approve, the Underwriter and Loan Officer draw up closing loan documents and disburse the loan to the Borrower.

Elmseed Enterprise Fund Underwriting:
The loan application consists of a detailed executive summary and projected cash flows for the business. References should be from former employers, church or community leaders, and current or past landlords, and Elmseed will provide the recommendation form that needs to be completed. Tax returns may be 1040s, 1099s, or W-2s; under extenuating circumstances, clients may substitute other financial documents by arrangement with the Elmseed Executive Board. As soon as all materials are submitted, the Elmseed Executive Board will review the client’s application and present it to the Board of Directors. The loan review process will be completed within one month from the time a loan application is submitted.

Elmseed requires the following from loan applicants:
  • Elmseed membership in good standing
  • Submission of a completed business plan
  • Submission of a loan application form
  • Submission of three references, including at least one employer or landlord reference (other references may be substituted with the approval of the Elmseed Executive Board)
  • Submission of a signed copy of the applicant’s most recent tax return (1040, 1099, and W-2 are all acceptable; clients may substitute other financial documents by arrangement with the Elmseed Executive Board).
  • Submission of additional financial documents (older tax returns, pay stubs, etc.) is welcomed and may work in the applicant’s favor.
  • On a case-by-case basis, Elmseed may ask a loan applicant to recruit a co-signer for his or her loan.

In addition, Elmseed will consider the following in determining whether or not to make a loan:
  • The quality of the loan application and the business plan upon which it is based.
  • The repayment history of the member, if it is a second loan.
  • The attendance history and participation of the member.
  • The member’s recent efforts to develop better business skills.
  • Business licensing and registration, where applicable.
  • The existence and status of personal savings.
  • The existence and status of business savings.
  • The borrower’s management of personal and business finances.
  • The borrower’s assistance of other Elmseed entrepreneurs.
  • The borrower’s participation in “full-membership” meetings.
  • The borrower’s payment of an initial (one-time) $30 membership fee and annual $10 membership fee thereafter.

Loan Closing

If the loan is approved, the last step is to sign closing documents and disburse the loan. Lend for America offers a resource library to its members that includes examples of the documents listed below. More information about membership is available on the Lend for America website. There are several steps in this process and each lender decides its own process. Descriptions of the most typical set of documents included in loan closing are below.

Loan Agreement

The loan agreement outlines the terms of the loan and is signed by the lender and the borrower. The agreement includes the policy for late payments, notification of credit reporting and pulling the consumers’ credit report, and all other fees (closing fee, returned check fee).

Promissory Note

The promissory note is a document the borrower signs that makes a promise to pay the loan back. The principal, interest rate and maturity date are included in this document.

Payment Schedule

A one page outline of the loan amortization schedule showing the original loan amount, interest rate, and payment schedule is helpful for borrowers to clearly understand the payments due.

ACH Authorization Form and Disbursal

The best way to disburse a loan is via ACH payments (electronic checks). It is also easiest to collect payments electronically with an automatic bank debit each month from the borrower's account. If a borrower accepts his loan via direct deposit, he must give the lender the correct bank account information. This arrangement brings incorrect account information to light immediately, making it easier to fix. To encourage timely payments, lenders can request authorization for recurring debits from the borrowers’ checking account. Lenders can use an ACH recurring payment authorization form to make this arrangement with your borrower.

Servicing and Accounting

Once the loan has been disbursed, the loan fund has to manage collecting and tracking monthly payments, known as loan servicing. Additionally, it is important to do accounting for anytime money changes hands in your organization. There are software programs created to service loans and some are coupled with accounting systems. As a start-up, these programs are likely out of your budget and since you will start with low volume, it is possible to rely on an excel sheet. To learn and practice servicing a loan, try creating your own excel sheet for managing loan payments. Lend for America also has some examples available for members in our Resource Library. For accounting, Intuit’s Quickbooks is web-based, inexpensive ($13 per month), and offers sufficient functionality.

In practice, servicing commonly follows a process similar to this example: your organization has disbursed a loan via ACH so the total loan amount has been deposited in your borrower’s checking account. It is easiest to set up a direct ACH debit each month on set dates, like the 1st or the 15th, for the borrower to make on-time payments. You can set this up using PaySimple. After these dates, you check your bank balance to see deposits have come in. These payments need to be recorded as cash coming in (in Quickbooks) and as payments lowering the loan balance (in Excel).

This is just one example. Best practice is to find a system that you can rely on as you grow to serve more clients. It will be easier to serve more clients as your organization grows if you implement these systems early on. Resources and recommendations on general nonprofit accounting are available from the Nonprofit Finance Fund and the Nonprofit Assistance Fund.

What happens if ACH fails?
If ACH fails, the staff accountant or loan officer should reach out to the borrower to figure out what might have gone wrong. Often, a clerical error has caused ACH to fail or there will be another practical explanation. Sometimes your client has overdrawn her account and is unable to make the payment. In this case, you may implement your collections practices.

Late Payments and Collections

Collections is the process of tracking and getting back late payments from borrowers. Each lender establishes its own late policies, late fee structures, and collections practices. The best thing to do when your borrower is behind is to maintain communication with her. Keep in touch by calling her everyday, go visit her, and emphasize that you would like to help her make a payment. Through communication, you will probably uncover the reason the she missed a payment and sometimes you can be helpful. For instance, your client might be waiting to collect a payment herself from an outstanding contract in which you case you could offer to connect her with a lawyer.

During your conversations, keep in mind that you are not trying to wring the money out of them like a loan shark. This approach will likely result in a period of radio silence during which your chances of recovering the loan dwindle to nearly nothing. On the other hand it is important to keep in mind that you expect to recover the outstanding balance. The answer may be to restructure the loan to receive partial payments (even just the interest) or consider extending the loan term to keep the borrower in good standing and to keep cash coming in.

Below is an example of a late payment and collections policy taken from Elmseed Enterprise Fund's staff manual.

A “timely” loan is one that is completely paid off within 13 months of the initial loan disbursal and with no more than 3 late payments. A payment is considered “late” if it is made 5 or more business days after the scheduled payment date.

Late payments, however, will not only reduce a client’s chances of receiving a second loan, but will also increase the annual interest rate for that second loan. For each late payment after the 5th late payment made during the first loan, the interest rate on the second loan will be raised by 0.5% from the base interest rate of 10%. For example, if a client with 9 late payments applies for and receives a second Elmseed loan, then his or her annual interest rate for that loan is 10 + (4*0.5) = 12%. However, a client with 3 or fewer late payments and who pays his/her loan within 13 months will not only receive a 10% interest rebate on his/her first loan, but is also eligible for a second loan at the reduced annual interest rate of 8%.

Clients with payments that are more than 5 business days late will be reminded of this delinquency through email by a finance staffer and on phone with their client service staffer. Clients with payments that are more than 30 days late will receive phone calls from either the Client Service Director(s) or the Executive Director(s). After that, if the client still refuses to make the scheduled payments, Elmseed will begin a more active loan collection process, including sending out a demand letter and pursuing the loan in either a small claims court or through a collection agency.

Credit reporting

Credit reporting is the process of sending loan repayment information for each of your borrowers to the credit bureaus. This data is compiled with other reported information and used to give consumers a credit score.

In order to credit report, your organization must become a member of Credit Builders Alliance (CBA). As a CBA member, your organization is able to send loan repayment data to TransUnion and Experian, 2 of the big three credit bureaus.

There are a few steps to get your organization ready for credit reporting. Generally, the most time-consuming step is preparing your data. Credit bureaus only accept consumer loan information in a file format called Metro 2. This file format can only be produced with software, it cannot be created manually. There are a few affordable options for purchasing this software including:

  1. The Service Bureau: Credit Reporting only, Software, $399
  2. LERA data: Credit Reporting only, Online based, $25/Month
  3. Downhome Loan Solutions: Loan servicing & credit reporting software, $2000+, includes TA
  4. Portfol: Loan servicing & credit reporting software, $2500+

Additionally, the Fair Credit Reporting Act (FCRA) mandates that data furnishers report accurate and complete data. It is important to make sure you are reporting correct information on your borrowers. Other requirements to credit report through CBA include: physical office space, public listing of address (yellow pages.com), annual membership fee ($925), contracts, copy of promissary note and example loan applications from 3 clients.

Contact information for CBA: info@creditbuildersalliance.org; www.creditbuildersalliance.org; 202-730-9390.

Product delivery via third party

Some student MFIs, especially smaller ones and those that are organized as a club as opposed to a separate non-profit, would rather focus on client recruitment and interaction as opposed to loan booking, servicing and in some cases underwriting. In the third party delivery model, another organization actually issues the loan, handles repayments and, depending on the nature of the partnership, does underwriting.

Advantages:
  • Simpler: The third party model saves student MFIs the hassle of loan tracking, loan servicing, etc. The MFI can then focus on the “fun” stuff—such as interacting with and recruiting clients.
  • Easier to start: This model makes it much easier for an MFI to start doing lending quickly, because it doesn’t require the development of a loan infrastructure.
  • Works well with student schedules: Even during the winter and summer breaks, or when student staff are busy with exams, the professional MFI will be able to continue to service and manage the loan accounts.

Disadvantages:
  • Less control/autonomy: depending on the nature of the partnership, you will have less control over who gets a loan and less ability to do other things—such as restructuring loans and rolling out new loan products—on your terms
  • Sustainability: with turnover of student staff and changes in any of the two partnering organizations, the partnership may flounder, leaving the loan program up in the air.

FAQS - LOAN DELIVERY

Should our Spanish-speaking clients be signing Spanish promissory notes and personal guarantees, or should they be signing ones in English?
Yes, you are required to provide all closing documents in Spanish -- these are the ones that get signed.

We have all the documents in Spanish, but the translations were not vetted by a lawyer. Are the documents still legally binding?
In theory, yes, they should be written by a lawyer. In practice, your documents are no less legally binding if they are not written by a lawyer. Just like in English, you may not word every clause precisely but it only matters if you take someone to court.

CIVIL JUDGMENTS: If a client has resolved a judgment and is making payments on them, shouldn't that be considered just as a past due balance would be or as another debt payment that the client makes every month? Does the creditor have a claim on all of the client's assets much as a tax lien does?

Legally: A judgment is a claim on assets, and allows the plaintiff to seize assets or garnish wages. A payment plan does not satisfy the judgment, even if a number of payments have been made on time in accordance with the plan. As far as the court is concerned, a judgment is outstanding until it has been paid in full. A payment plan is simply an arrangement between the parties.

Practically: Most civil judgments are rarely collected on in this fashion, due to the difficulty in tracking the debtor down, the unlikelihood that he will have any assets, and the expense involved. So, the "claim on assets" isn't an imminent threat in most cases. We still decline folks with judgments, however, because we've found them to be very poor risks in general (the judgment is a sign of more problems that are discovered later). As far as payment plans go, we've often seen folks who are declined try to "explain away" the judgment by providing evidence that they have a payment plan when they haven't made any payments yet (so all they did was call and get a piece of paper). To me, that doesn't change much. If a client could demonstrate several months of on-time payments (difficult as they are not on the credit report), we might consider it if the judgment was small and/or old, the loan amount was small, and we had full collateral.

Also, we try to advise that it's almost never a good idea to enter into a payment plan to satisfy a judgment, as the full amount will likely have to be paid. It's better to save-up and make a lump-sum settlement offer, where the plaintiff may accept 60-80% of the judgment amount.