Many lending organizations are moving to a score-based system of approving or declining certain loan requests. The scorecard process awards points for certain aspects of the loan application and deducts points for others; combining to form a score that will be compared against the standards set by the lending institution to form a decision. The scorecard system has numerous advantages and minimal disadvantages.
For some, scoring loans may be compared to running cattle through a chute. While that may first seem like a bad thing, let’s consider it. When you’re working cattle and roping, tying, and handling each head individually you have increased input costs, possible operator error and, most importantly, more time involved. Instead, say you gather the cattle, put them in the corral and establish a process of working your stock that fits your operation and allows you to cut down on costs, as well as the time spent on each animal. All the while still devoting time to each one and simultaneously making your operation more efficient. This is the exact thought process that is leading many lenders to a score-based system for certain loan types and dollar amounts.
While each organization can modify or create a scoring system that suits their needs, most are similar. Basically, the idea is to consider and weigh the variables that define the amount of risk the lender faces with that particular loan request. The factors scored continually evolve to better suit the always-changing lending environment.
Some of the potential parameters that can influence a score:
• FICO score
(various factors relating to credit history)
• years involved in operation
• previous experience with lender
• loan-to-actual-value of collateral ratios
• owner’s equity/ current ratio
Since the scorecard system works to put a value on the risk associated with a loan, FICO scores and credit history are the most common factors used. This might include a point value that decreases as your credit score decreases, because perceived credit risk increases with lower credit scores. Another credit history factor could be the amount of revolving credit that an individual has. For example, a credit card that is nearly maxed out. A farming operation that has been functioning for years may garner additional points while a start-up will receive fewer, or none. Previous experience with the lender may also lead to the addition or subtraction of points, depending on the experience. All of these things, and more, make up an applicant’s total score.
As with any loan approval process, the best thing a borrower can do is ensure they maintain a strong FICO score and prepare themselves to accurately detail their financial position to the lender. Be prepared to articulate your loan purpose and need, as well as available collateral.
While not every loan is scored, a substantial number of lending institutions are moving toward this system. Scored loans save time and a scoring system allows a lender to gather needed information and provide their prospective customer with an answer much more quickly than alternative systems. Scoring loans also decreases the lender’s costs which should result in fewer fees charged to borrowers.
The scorecard process is a win for both borrowers and lenders and should not be feared. Lending institutions are able to provide more consistent and accurate service and the efficiency of the loan process saves both parties time and money.
Norm Clayborn is a credit analyst with Farm Credit of Western Arkansas
