Lending has changed a lot over the last several years. In our grandfather’s era a person of good character could borrow money on the signature of their good name for many purposes, or if they obviously had adequate security for the requested loan.
Even in our grandfather’s day lenders considered the three C’s of credit, capacity, collateral and character.
Today agricultural lending has become much like commercial lending, where the borrower might have to present a business plan to show the cash flow direction and repayment ability, have records to back it up, an appraisal to support the value of the security and a credit report that verifies you have a history of paying your obligations.
This brings us to how lenders use all this information to determine if an applicant is deserving of a loan.
Capacity or Repayment Factors
1. Records – Many times a lender will want to review three to five years of records which generally includes 1040 F forms from the Federal Income Tax. This is very important to lenders when reviewing a loan application.
The key factor in reviewing records from past years is to look at trends in spending and income, and to compare projected income to income in past years.
This is especially important when going over applications for refinancing existing loans with a different lender. The lender will want to be clear the applicant is not projecting income that appears unobtainable by the borrower.
In general, farmers do not like to keep records. Many still use the “shoe box method” where all the year’s receipts are thrown into a shoe box until time to prepare the income tax return. A seasoned lender can spot this kind of record keeping.
2. Structure – The ideal credit structure for a farm operation is for long term assets (such as real estate) to be financed on long term loan obligation, such as 15 years or greater. Intermediate assets (such as foundation livestock or even some machinery and equipment) should be financed for a term of 3 to 10 years, depending on the life of the asset. Credit for short term operating such as annual operating loans should be on a one-year loan (depending on the purpose of the loan). Some operating loans can be structured on a Revolving Line of Credit, which is a good way to handle seasonal needs.
Sometimes a refinance/restructure is needed to get the debts structured properly to prevent cash flow problems.
Collateral
Collateral is determined through appraisal of the collateral offered to secure the loan. This can be done by something as simple as a NADA auto value book, or a Hot Line Book on tractors and machinery. It can be an onsite item by item inspection and evaluation of individual pieces of equipment.
A real estate appraisal should be done by a State Certified Appraiser. An appraisal should be considered as one person’s opinion on one given day. The type and size of the loan request will determine the extent of the appraisal required to made the credit decision.
Character
Character is determined through evaluation of credit.
The credit score is another tool to analyze the credit application. The credit score is provided by any of the three national credit bureaus. There is a variance in scores from the three bureaus, just as there can be a variance in appraisers with the value of property. Generally a credit score tells the lender how the applicant has paid obligations in the past and assigns a rating performance.
A credit score of less than 550 is generally unacceptable, a score of 650 is considered quite adequate for most applications, greater than 700 is good to very good, greater than 800 is excellent.
Some factors outside a consumers’ immediate control can affect the credit score, such as how many times an inquiry is made on you. The best example is car shopping. If a consumer has 10 inquires pulled in a short time it could result in a lower score.
Under the Fair Credit Reporting Act, each consumer is allowed to have a credit report form each of the three bureaus each year free of charge. However, the free reports do not give you a score. If you want your score you have to pay for it.
Mike McCorkill is with the Bank of Ash Grove, in Ash Grove, Mo.
