Credit is important to bankers because it tells the story of your financial habits and history. Essentially, your credit score records how you repay the money you have borrowed. It also describes what types of loans you have. Revolving loans are measured differently than installment loans. When you ask to borrow money, the banker needs to trust that you will pay it back. They also want assurance that you will make the payments on-time and as agreed. Thus, your credit score and history are paramount to a banker.
Your Financial Habits
A credit score can help determine your financial habits. Bankers will closely review your habits to assess their risk when lending you money. They will look at the total amount of loans you have, your payment history, and your credit utilization (ideally this should be around 30%). For example, if you make your payments late each month, then you would be considered high risk. Or if you have a lot of loans, you may also be considered high risk due to the amount of debt you have. Lastly, you are considered high risk if you max out your lines of credit (revolving debt). Ideally, bankers like to see 3-revolving loans with 30% utilization and 2-installment loans — and all payments should be on-time, as agreed.
Loan Default Risk
Bankers use your credit score as a tool to assess the likelihood that you will repay the loan. A high credit score lowers the risk, and a low credit score increases the risk. A high risk borrower increases the probability of default. Therefore, a high credit score is critical because it shows the banker that you can be trusted and will not default on your loan.
Your credit score is also used to determine the interest rate you will get. Some bankers will not loan to someone with a low credit score, while others specialize in “subprime” loans. Subprime borrowers usually have a higher probability of defaulting on their loan so their interest rates are usually high. Prime borrowers have a credit score of 720 or above, and bankers will generally offer the best rates to prime borrowers. Borrowers may be able to get a loan with a lower credit score but anything below 650 can be very difficult.
Did you know that bankers are using alternative tools to determine if you are creditworthy? While it is extremely important to have a good credit score, many bankers are also looking elsewhere to assess your default risk. They may be looking at your utility payment history, cell phone usage, social media accounts, and your overall online identity. Many bankers comb through social media to vet a business before approving the loan. They look at the reviews, comments from customers, and interactions between the business and it’s customers. We suggest that you do a periodic search of your name and/or business name to see what comes up on popular search engines. You can read more about alternative ways lenders determine if you are creditworthy here.
In closing, it is imperative to have good credit when you are considering a loan. We recommend pulling your credit report from all three credit bureaus once a year to check for erroneous information. Experian, Transunion, and Equifax all offer a free annual credit report so you can review your report periodically.