Understanding the 5C's of Credit- Module 2
We all should understand two things about credit. First, your credit is used to profile you, thus determining what time of the person you are based on how you handle your credit. Lenders use this information whether to approve you for credit, what rate to charge, and how much they will fund you for. Insurance companies determine whether you are high risk and employers decide whether to hire you. Secondly, although you may have an acceptable FICO score, it may not be enough to get the credit you are looking for. For example, having 3 accounts, 2 that are a year old and the other is 2 years old does not provide depth or history of your credit report, even though your score maybe 700. The other thing that is looked at is the amount of credit you have been approved for, so if you have those same credit cards with approved amounts of $500 each, this will limit the amount you will be funded for is because lenders seem to follow each other and add only maybe 25% to those other approved amounts.
Credit reporting is an ongoing process to try to perfect its accuracy. During the early 2000s when mortgage lenders had products like stated income and no doc loans for residential financing, they were learning as they went along. It started that 620 FICO was acceptable for stated financing (where you did not have to prove your income-you just stated what you made, within reason). As lenders learned this FICI slowly crawled up to 680 Fico. The other problem that lenders did not perceive was the depth of the credit, they were mostly based on the credit score itself. This meant that people who were not used to making large payments were buying homes where the payments were $3200 a month when their total monthly bills including rent, car payment, and credit cards were only $2500. Although foreclosures ticked up to a high level, inventory was moving fast, so nobody seemed to care.
The recession and devastation to the real estate and credit markets made the credit facilities focus more on the credit scoring model, especially with lenders requiring a better understanding.
That is why more than ever the 5C’s of credit plays a major factor in all lending and credit characterizations of credit.
The importance of the 5C’s of credit is paramount if you are running a business, or you’re in the business of funding commercial real estate or small businesses. Reviewing and understanding the credit will save a lot of wasted time submitting deals that don’t fit the criteria. Understanding will also allow you to possibly provide a path for the client that will best fit their needs.
Let’s talk about business startup funding. There are a few options for this including Personal Lines of Credit, SBA, and equipment financing. To maximize funding with any of these programs, lenders are going to look and rely heavily on the 5C’s of credit, especially the collateral part. This means that owning a home will be weighted as a positive. Even with the personal lines they will be limited, even with the other 4c’s in place, it will take a lot more work to get them the money. So imagine how it will be to get the money they need with a couple of the other proportions of the 5C’s is missing.
If the client is not properly prepared to obtain the funding needed you can work with them on a program to get where they need to be. You can get them in the credit repair and credit builder program so that they can get their credit where it needs to be, to get them the funding they need to get started. If they are already in business and need financing you can provide the needed funding if possible and get them into a program that helps them build their personal and business credit and work with them through our accounting program to get their business in financial shape. Working this way provides you a path to help the client reach their goals, build a future of low-cost financing, grow their business while you don’t waste time working on something that won’t transition and you earn money now.
Understanding FICO Scores
The acronym FICO comes from the company that originally introduced such scores. Almost three decades ago, Fair Isaac Corporation established what is known today as the FICO score or credit score.
FICO uses a formula they own the rights to, applying it to credit reports from three reporting agencies: Experian, TransUnion, and Equifax. The three credit bureaus monitor any loans or credit a person has received. They note how quickly the loans are repaid and take note of any issues with collecting payment. In most cases, each bureau has varying information that is used to compile a FICO score. Using online sites to check for a FICO score typically involves compiling different scores to create one basic score.
Scores range from 300 (worst) to 850 (best).
An individual with a FICO score of 800 or above has an exceptional credit history. A person with a high credit score has likely had multiple lines of credit for many years. They haven’t exceeded any of their credit limits and have paid off all their debts promptly.
FICO scores in the mid-to-upper 700s are good scores. Individuals with a score in this range borrow and spend wisely and make timely payments. These individuals, like those in the 800+ range, tend to have an easier time getting credit and typically pay significantly lower interest rates.
The most common scores sit somewhere between 650 and 750. While the individual with a score in this range has fairly good credit, they might have had some late payments. These individuals typically don’t have a difficult time getting loans. However, they may have to pay slightly higher interest rates.
The last real range to consider is a score of 599 or lower. They are considered poor credit scores and usually result from multiple late payments, failure to pay off debts, or debts that have gone to collections agencies.
Every Lender, Creditor, Insurance company, etc. review every applicant for credit risk. They are all in business to make money. They will review every application based on their risk underwriting guidelines.
As a financial intermediary, you must understand credit risk. You must act as a preemptive barrier by reviewing the documents of the file, you must know what to ask for, how to review it, and how to structure it for fast approvals.
I have had hundreds of representatives get angry when we ask for additional paperwork. You must understand that many times the documents submitted open up the file to other questions. A bank statement can show a payment to another lender that was not disclosed on the application, that warrants a question and supporting documents. People try to hide things thinking you will never find out, but we do. So you spending a few minutes reviewing the file, and explaining to the client how important it is for them to be honest with you will help the deal go smoother. Many times when these things pop up the file is denied, and that means it was a waste of time for everyone.
What Factors are Used to Assess Credit Risk?
To assess the credit risk associated with any file a variety of risks relating to the borrower and the relevant industry must be considered.
- The financial position of the borrower, by analyzing the quality of its financial statements, its past financial performance, its financial flexibility in terms of the ability to raise capital, and its capital adequacy ( do they show a profit- many small businesses show a loss in order nit to pay taxes. When applying for A-type financing the financials are reviewed and if a loss is shown, they have no money available to repay the loan).
- The borrower’s relative market position and operating efficiency (are they efficient and viable)
- The quality of management, by analyzing its track record, payment record, and financial conservatism ( the business does not overspend, and payables are timely)
- The competitiveness of the industry
- Certain industry financials, including return on capital employed, operating margins, and earnings stability
We have dived deep into a little more than understanding credit, but it’s important that you start with the credit, and based on that you should start to develop a picture of how to handle the clients’ needs. Moving on to the bank statements and then the financials will complete that picture, and then it’s time to properly structure by assuring you have the answers to any questions that may pop up.
Underwriters do not like piecemealed docs. Once they find one thing to question the more they look for other things that may be wrong leading to a possible denial.
At Ebizmore we look to get deals approved and look for every way possible. We are the most progressive lender in the industry. Small business is the heart of our community and every community throughout the country.
If you have any questions or need to know more contact us at firstname.lastname@example.org.
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