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In: Finance

Discuss the principles of appraisal and you opinion of the importance of appraising to the lending...

Discuss the principles of appraisal and you opinion of the importance of appraising to the lending process.

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Expert Solution

Banks follow the following principles of lending:
1. Credit History: A borrower's reputation or track record for repaying debts. This information appears on the borrower's credit reports. Generated by the three major credit bureaus—Experian, TransUnion, and Equifax—credit reports contain detailed information about how much an applicant has borrowed in the past and whether they have repaid loans on time. These reports also contain information on collection accounts and bankruptcies, and they retain most information for seven to 10 years
2. Capacity: Capacity measures the borrower's ability to repay a loan by comparing income against recurring debts and assessing the borrower's debt-to-income (DTI) ratio. Lenders calculate DTI by adding together a borrower's total monthly debt payments and dividing that by the borrower's gross monthly income. The lower an applicant's DTI, the better the chance of qualifying for a new loan
3. Capital: Lenders also consider any capital the borrower puts toward a potential investment. A large contribution by the borrower decreases the chance of default. Borrowers who can place a down payment on a home, for example, typically find it easier to receive a mortgage. Even special mortgages designed to make homeownership accessible to more people, such as loans guaranteed by the Federal Housing Administration (FHA) and the U.S. Department of Veterans Affairs (VA), require borrowers to put down between 2% and 3.5% on their homes. Down payments indicate the borrower's level of seriousness, which can make lenders more comfortable in extending credit.
4. Collateral: Collateral can help a borrower secure loans. It gives the lender the assurance that if the borrower defaults on the loan, the lender can get something back by repossessing the collateral. Often, the collateral is the object one is to borrow the money for: Auto loans, for instance, are secured by cars, and mortgages are secured by homes. For this reason, collateral-backed loans are sometimes referred to as secured loans or secured debt.
5. Conditions: The conditions of the loan, such as its interest rate and amount of principal, influence the lender's desire to finance the borrower. Conditions can refer to how a borrower intends to use the money. Consider a borrower who applies for a car loan or a home improvement loan. A lender may be more likely to approve those loans because of their specific purpose, rather than a signature loan, which could be used for anything. Additionally, lenders may consider conditions that are outside of the borrower's control, such as the state of the economy, industry trends, or pending legislative changes.

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