By Sean Terrazas, Credit Underwriter – Houston Business Development, Inc.
How do lenders determine the credit worthiness of borrowers? In general, financing institutions determine who they will extend credit to based upon five key factors or the “5 C’s of credit:” character, capacity, capital, collateral, and condition. Character, being one of the root qualities and foundation for other borrower characteristics, describes the manner in which borrowers manage all aspects of their financial lives. The quality lends itself to the general impression you make on prospective lenders or investors, and allows institutions to form a subjective opinion as to whether or not you are sufficiently trustworthy to repay the loan and/or achieve an exit strategy. Institutions evaluate financial information, educational backgrounds, experience in business, and the quality of trade references among other items to fuel their decision making.
The overall character of individuals and businesses is also displayed through the handling of credit. Borrowers’ who effectively ration their monthly cash flow are able to pay monthly “contractual agreements” – bills that may include real estate mortgage payments, installment loan payments, revolving debt payments, and auto loan payments to name a few – ahead of due dates with money to spare. Generally speaking, a contractual agreement involves receiving something of value now with the intention to repay the lending institution at some later date.
Paying obligations in a satisfactory manner, on a consistent basis, establishes a positive “reportable” borrowing history which enables creditors to disseminate the information to credit bureaus (Equifax, Experian, and TransUnion) – information that drives credit scores upwards. The FICO score (Fair Isaac Corporation) is a popular scoring method used by lenders which analyzes credit information reported to apply a credit score between 300 and 850. On average, borrowers tend to score in the 600 – 800 range with those scoring in the 720 and above vicinity being able to obtain the best terms. Conversely, those borrowers scoring in the range of 620 and below tend to encounter more challenges in obtaining credit.
The credit scores take into account the number of open accounts, current account balances versus the original amount or credit limit (usage), the number of months / years that accounts have been paid, payment performance, number of credit inquiries, and other indicators to determine the likelihood of default. Although this is not an exact science, the FICO score is a strong indicator of the propensity to pay and recognized by lenders as such across the industry.
Whether you are a sole proprietor or corporation, solid credit should never take a back seat to managing your business. The challenging credit environment will always demand scrutiny of character, and credit is one of the key ingredients to establishing lender rapport. Although all of the “5 C’s of credit” are important underwriting markers, HBDi views character as the single most important determinant in guiding its lending decisions.
Through various loan products, HBDi is able to provide low-interest rate financing for working capital, equipment, furniture and fixtures and real estate acquisition ranging from $5,000 to $5 million. To learn more about the services of HBDi contact a loan officer at 713.845.2400.