Many times customers, especially those just getting started in the industry, wonder why credit is so important in commercial lending. I can tell you, sometimes it’s easier to buy a brand-new car than a used piece of equipment. In this article, we will go over the importance of credit in commercial lending. Let’s start with the basics.
What is credit? Credit is the power to borrow money for things such as equipment for a business, as well as the purchase of a home, car, etc. There are two types of credit reported on a credit report.
Types of credit
The first is revolving credit. Revolving credit is a type of account that is used to borrow money and reborrow indefinitely, as long as you pay down the balance and remain within your credit limit. Credit cards and home-equity lines of credit fall under this category.
The second is installment credit. An installment loan is a fixed sum of money you borrow upfront and pay back with interest. The payments are made in fixed, equal amounts over a set term. Common installment loans are personal loans, auto loans and debt-consolidation loans.
Credit-worthiness factors
What is a credit score and what does it mean? A credit score enables a lender to determine a potential borrower’s credit worthiness. A variety of factors affect your credit score. One item lenders look at is payment history. How often you make payments on time, late or not at all impacts your credit score and gives lenders insight into how likely you are to repay your debts as agreed.
Next, they look at credit utilization. Credit utilization is the amount of revolving debt, including credit-card debt, being used.
Revolving debt consists of the balances you carry on any revolving credit lines you have open. These let you borrow money up to an approved limit, pay it back and borrow again as needed. There are no specific loan terms for revolving debt, and it often comes with a variable interest rate. The most well-known type of revolving debt is credit-card debt, since card holders can carry a balance if needed. Other forms of revolving debt are lines of credit and home-equity lines of credit.
For example, if you have a $3,000 limit and a balance of $300, your credit utilization is 10%. The lower the utilization, the better for your credit score.
Another factor is length of credit history. Credit history is a measure of how long you have been using credit products. A lengthier credit history can help you achieve a higher credit score.
Using a mix of credit products such as credit cards, a mortgage, student loans and auto loans indicates to lenders that you have experience managing a wide variety of credit products.
New credit is another factor. A credit check associated with an application for new debt can result in a hard inquiry on your credit report. This can cause a slight, temporary dip in your score. The appearance of new debt also can affect your score.
Managing credit responsibly
How do you manage credit responsibly? It starts with making on-time payments. Paying at least the minimum payment on a credit card or an installment loan is essential for building and maintaining credit. Late payments can stay on a credit report for seven years and affect the credit score for the entire time. Don’t spend more than you can afford to repay. Credit cards can be a good way to use credit if used properly. But if you carry a high balance over time, the interest you accrue can make it hard to pay down the debt.
Finally, keep old accounts open. The average age of your credit accounts has an impact on your score, so it’s often in your best interest to leave the oldest accounts open. Doing so also can keep your credit utilization low, as you will have a higher amount of available credit and will avoid what is known as a thin credit file.
When is credit health important?
The following are a few scenarios when your credit health is important.
Applying for a credit card: Your credit impacts which credit cards are within your reach. A higher credit score may grant access to cards with competitive terms, such as reward benefits, low interest rates and other perks. Conversely, a lower credit score may disqualify you from credit cards or limit you to a secured credit card that requires a security deposit, or a credit card with a higher interest rate and a low credit limit.
Setting up insurance and utilities: Some utility and auto-insurance companies run a credit check when you apply to determine the likelihood that you will pay your monthly bill. A service provider may require a deposit before they set you up if they notice red flags on your credit report.
Applying for a job: Some employers run credit-report checks as part of the application process.
Starting a business: This comes into play in commercial lending. If you are considering starting a business and taking out a loan to fund your new venture, you will need good credit to qualify for a small-business loan.
Beyond the credit score
As you can see, there are many determining factors that can affect a credit report. When I am speaking with a new customer and I ask them what their credit score is, often the response is “It’s great, I have a 740 score.” When the application comes in and the credit report is pulled, the applicant has only three tradelines.
A tradeline is a record of activity for any type of credit extended to a borrower and reported to a credit-reporting agency. According to Nerdwallet.com, having too few tradelines in your credit history can make you “unscorable,” or can mean you have a thin credit file. Either of those can get in the way of having a good credit score. Having more than three tradelines lifts you out of thin-file territory.
The tricky part of a credit report can be that the score you see is not necessarily a true representation of the applicant’s true credit worthiness. The report is a history of how credit is handled. I hear often from potential customers that credit cards are bad, and many folks pay off their balance and close the account. However, credit cards can be the best way to use someone else’s money. Paying off the entire balance when it is due gives you free money for 30 days. And keeping them open can improve your credit score.
Conclusion
There are three credit-reporting agencies from which you can request your credit report. It is always good to know if there are items in the report that are not accurate and need to be corrected. The stronger your score, the better rate you will be offered, and you may even be in a better negotiating position.
In order to get credit, you need to have credit. It starts with a small loan and works up from there. Credit is key in building your business.
Liz Boone is director of operations at Streamline Financial Services, a six-year TCIA corporate member company based in Suwanee, Georgia.
This article is based on her presentation on the same topic during TCI EXPO ’22 in Charlotte, North Carolina. To listen to an audio recording created for that presentation, go to TCI Magazine online at tcimag.tcia.org. Under the Resources tab, click Audio. Or, under the Current Issue tab, click View Digimag, then go to this page and click here.
