Loan appraisal

Loan appraisal is the structured assessment a lender carries out on a loan application to establish whether the borrower can repay, whether they are likely to, and what amount, term and security the loan should carry. It produces a recommendation; it does not make the decision.

Appraisal sits between application and approval. Everything before it is collection — forms, documents, identification. Everything after it is authorisation. Appraisal is the part where evidence is turned into a judgement, and it is the point at which most of a loan book's eventual performance is determined. A loan that should not have been written cannot be serviced or collected back into health.

The output is a written recommendation, usually called an appraisal report or credit memo, covering a proposed amount, term, repayment structure, pricing, security and conditions, together with the reasoning and the evidence behind them. The person who prepares it is normally not the person who approves it.

Appraisal of the loan, not appraisal of the asset

The word carries two meanings, and the search results for it mix them freely.

• Loan appraisal, as used here and throughout microfinance, development finance and most Commonwealth lending practice, means the credit assessment — evaluating the borrower and the proposal.
• Appraisal in North American mortgage usage usually means the valuation of the property, carried out by a licensed appraiser to establish the figure that drives the loan-to-value ratio.

The second is one input into the first. A valuation tells you what the security is worth; it says nothing about whether the borrower can pay. Where documentation is used across markets, spelling out "credit appraisal" or "collateral valuation" removes the ambiguity entirely.

Related terms with overlapping meanings:

• Loan appraisal — The whole assessment: borrower, proposal, security, recommendation.
• Credit appraisal — Same thing; interchangeable in most institutions.
• Underwriting — Same activity, more common in banking and consumer lending; often implies a more rules-driven process.
• Credit analysis — The analytical component, particularly of financial statements and cash flow.
• Due diligence — Broader verification, common in corporate and project finance.

Where appraisal sits in origination

1. Enquiry and screening — is this borrower and this purpose within policy at all?
2. Application and document collection — identity, income evidence, business records, security documents.
3. Verification and KYC — confirming that the documents and the person are genuine.
4. Appraisal — site visit, cash flow analysis, credit history, security assessment, written recommendation.
5. Approval — a separate authority accepts, modifies or declines the recommendation.
6. Offer, acceptance and documentation — terms are issued and agreements signed.
7. Disbursement.

Steps 4 and 5 must be held apart. Where the person who appraises also approves, there is no second judgement in the process, and the entire control depends on one individual's incentives. See approval workflow for how that separation is normally structured.

The five Cs of credit

The standard framework for what an appraisal examines. It is old, it is a mnemonic rather than a model, and it remains the most useful checklist in lending because each C fails in a different way.

• Character (Will they repay?) — Credit bureau report, internal repayment history, references, trade suppliers, community standing, length of time in business.
• Capacity (Can they repay?) — Verified income, business cash flow, existing obligations, debt service ratio.
• Capital (What do they have at stake?) — Own contribution, business equity, savings, retained earnings.
• Collateral (What is the fallback?) — Security offered, ownership, valuation, enforceability, LTV.
• Conditions (What could change?) — Sector outlook, seasonality, competition, regulation, the purpose of the loan itself.

Capacity is the primary basis for lending. Collateral is the secondary. An appraisal that clears on collateral alone is not an appraisal — it is a decision to be repaid by enforcement, which is slow, expensive and only partly recoverable.

Appraising a business with no financial statements

Most borrowers in microfinance and small business lending have no audited accounts, often no accounts at all. The appraisal does not lower its standard in response; it changes its method. The loan officer builds the financial picture during the visit rather than reading one that already exists.

Reconstruct the cash flow from observation. Daily or weekly sales asked in several different ways and cross-checked. Purchase frequency and typical order size. Supplier names and terms. Stock counted and valued on the spot. Margin derived from actual buying and selling prices on the main lines, not from what the borrower says the margin is.

Treat household and business as one unit. For a micro-enterprise they are one pocket. School fees, rent, food and medical costs compete directly with the loan repayment. An appraisal that captures business surplus and ignores household expenditure will overstate capacity every time.

Verify against physical evidence. Stock on the shelves, equipment on site, the premises themselves, receipt books, mobile money statements, supplier records, the borrower's own notebook. Mobile money history in particular has become the most reliable single source of transaction evidence available for informal businesses.

Cross-check with third parties. Neighbouring traders, suppliers, the market association, the group. In group lending the members' willingness to accept an applicant is itself appraisal evidence, which is a large part of why village banking works.

Test seasonality. A trader appraised in a peak month and given a fixed monthly repayment will struggle in the trough. Ask what the worst month looks like and size the repayment against that, or match the repayment structure to the cycle.

Worked example: appraising a market trader

An applicant requests 30,000 over 12 months for stock. The loan officer visits, counts stock, checks buying and selling prices, and reconstructs the monthly position.

• Average daily sales: 1,200 × 25 trading days = 30,000
• Cost of goods sold (70% of sales): (21,000)
• Gross margin: 9,000
• Stall rent: (1,200)
• Transport: (800)
• Licences and market levies: (300)
• Casual labour: (1,000)
• Net business income: 5,700
• Spouse's income: 1,500
• Household expenses: (3,000)
• Available surplus: 4,200

The lender's policy caps debt service at 60% of available surplus, giving a repayment capacity of 2,520 per month.

The requested loan of 30,000 over 12 months at 3% per month on a reducing balance requires a repayment of about 3,014 — above capacity. Working backwards from 2,520 gives a supportable loan of roughly 25,000.

Appraisal recommendation: approve 25,000 over 12 months rather than the 30,000 requested, with the reduction and its basis stated explicitly in the report.

This is the most common and most useful outcome of a real appraisal. The binary approve-or-decline framing hides the fact that most of the value in appraisal is in sizing — finding the amount the borrower can actually carry, which is frequently less than they asked for and occasionally more.

The appraisal report

Whatever the format, the report should let a reviewer who has never met the borrower reach the same conclusion. At minimum:

• Borrower and business summary — who they are, what they do, how long, where.
• Loan request — amount, purpose, term, proposed structure.
• Purpose analysis — what the money will actually buy and whether that generates the repayment. A stock loan should show the additional margin the stock produces.
• Cash flow and affordability — the numbers above, with their sources.
• Credit history — bureau result, internal history, other lenders, any co-borrower or guarantor positions already held.
• Security — what is offered, who owns it, what it is worth, whether the charge is registrable, resulting LTV.
• Risks and mitigants — stated plainly. An appraisal with no risks listed has not been done.
• Recommendation — amount, term, rate, security, conditions precedent.
• Officer's name, date and signature.

The evidence matters as much as the conclusion. Photographs of stock and premises, GPS coordinates of the visit, copies of the documents inspected and the date of inspection are what make the file defensible later, whether to a regulator, an auditor, an investor or a court.

Judgemental appraisal and credit scoring

• Judgemental appraisal - Basis: Officer's assessment against a framework

  • Speed: Hours to days
  • Cost per loan: High
  • Handles thin-file borrowers: Yes
  • Consistency across officers: Variable
  • Adapts to unusual cases: Yes
  • Requires data history: No

• Credit scoring - Basis: Statistical model over historical data

  • Speed: Seconds
  • Cost per loan: Very low
  • Handles thin-file borrowers: Poorly
  • Consistency across officers: Complete
  • Adapts to unusual cases: No
  • Requires data history: Yes, substantial

Neither is universally better, and most lenders end up with both. A common structure is scoring or policy rules for small, repeat and standard loans, full appraisal for first-time borrowers, larger amounts and anything the rules flag. Repeat lending is where the economics bite hardest: a borrower on their fifth cycle with a clean record does not need the same appraisal depth as a stranger, and insisting otherwise makes small repeat loans unprofitable.

Where appraisals fail

Appraisal to a target. Officers with volume or disbursement targets and no counterweight on portfolio quality will find the numbers that support approval. Where incentives touch disbursement, they must also touch arrears on loans that officer wrote, with a lag long enough to catch them.

Coaching the figures. Sales estimates arrived at by asking "so you make about 1,500 a day, don't you?" Open questions, cross-checks and physical verification are the defence.

The copy-paste appraisal. Identical cash flows across different traders in the same market, or a report reused from the previous cycle without a fresh visit. Easy to detect on review and a reliable signal that appraisal has become a formality.

No site visit. For business lending the visit is the appraisal. Everything else is documents the borrower chose to provide.

Household expenses omitted. Consistently the largest single source of overstated capacity in micro and small business lending.

Appraising the security instead of the borrower. Comfortable collateral producing a thin assessment. The loan then depends on enforcement, which recovers less and later than the file assumes.

Stale appraisals. An assessment done four months before disbursement describes a business that may no longer exist in that form. Most policies set a maximum age, commonly 30 to 90 days, after which the position is refreshed.

No feedback loop. Appraisal quality only improves if someone compares appraisals to what the loans went on to do. Sampling early-arrears cases and re-reading the original report is the cheapest quality control available, and the most neglected.

Frequently asked questions

How long does a loan appraisal take?

From minutes for a scored repeat microloan to several weeks for a secured business facility requiring valuation, title searches and site inspection. Most small business appraisals involving a visit take one to three days of elapsed time.