Credit assessment has been an ongoing and emerging tool that has helped revolutionize the way car dealers determine an individual’s credit reliability. With the marketplace fluctuating on a daily basis, it’s important for these businesses to have all of the necessary tools available to them to evaluate credit risk. To aide in understanding how to assess credit liability, ZimpleMoney has created this guide which outlines five ways to evaluate credit risk to make it easier to manage and sell your loans and loan portfolio. This guide will cover areas which include; credit scoring, payment history, outstanding debt, length of credit history, additional intelligence and gumshoe intelligence.
Credit scoring is one of the most commonly used methods today to help determine an individual’s credit risk. The three major companies that help compile these reports are; TransUnion, Experian & EquiFax. According to investopedia.com, “A credit score plays a large role in a lender’s decision to extend credit and under what terms.” The range of an individual’s credit score can vary anywhere between 300 (which is considered a low credit score) up to 850 (which would be considered perfect credit.) Other factors that go into calculating a credit score are outstanding debt, the number of credit accounts maintained, age, income, credit history, etc. Credit Scoring is a valuable method used to help assess a person’s credit risk.
The following quote from BankingGlossary.net best summarizes credit scoring:
“Credit scores can help identify the credit risk of seasoned loans and help determine the appropriate grade (risk) pool into which individual loans should be placed for sale to the secondary market. Lenders may use credit scores to differentiate risk categories of loans for pricing decisions. Rather than reject higher-risk loans for origination or purchase, the lender may decide to price the risk by requiring an interest rate premium on those loans with higher predicted probabilities of default.”
In other words, credit scoring allows dealers to determine the loan rate at which they choose to charge the customer. Also, credit scoring often reflects the rate / speed in which the credit approval process happens. People with higher credit scores typically can get a loan approved at a much faster rate then people with lower credit scores.
Another important variable used in helping assess an individual’s credit risk is their payment history. This is a summary of payments a person has made on their bills and attests to the fact that they are making their payments on time. A business can quickly get an overall picture of the person’s financial position by analyzing their history of payments. Oftentimes, when a consumer has multiple missing or late payments, they can be classified as a higher risk candidate for loans. On the opposite end are those consumers which have a consistent history of payments and have not missed or been late on any payments. These people would typically be classified as lower risk candidate for lending.
Outstanding debt can best be summarized as “that portion of debt which remains unpaid.” This is another way in which independent auto dealers can quickly assess a borrower’s credit. Typically the more outstanding debt a consumer has the more likely they are suspect to default on a loan. Another term often associated with outstanding debt in the mortgage and real estate industries is the “debt to income ratio” or DTI. The DTI informs the lender as to how easy it would be for the consumer to repay the loan. A simple way of remembering the formula is total recurring debt (monthly) divided by gross income (monthly). This formula, along with credit scoring, are the primary means in which lenders determine whether or not a consumer is suitable for a loan. Most lenders/note buyers prefer a maximum DTI of 40%, so if you intend to sell a loan, keep this in mind.
Length of Credit History
Length of credit history is often times confused with payment history; however, they are entirely different. Things such as “time since accounts opened, time since accounts opened (by specific type of account), and time since account activity” contribute to the length of credit history. The length of credit history is also another big factor that plays into credit score. According to the Motley Fool, “fifteen percent of your credit score is determined by how long you’ve been using credit.” However, it’s not suggested to open multiple new accounts in the hope to build credit history, as that will only negatively affect the individual’s credit score. The consumer credit counseling service website summarized it best by saying “If your credit history is too short, there is not much of a picture for potential creditors to look at. In other words, you have not yet proven yourself. Because of this, you may be considered a higher risk.”
What is most significant about additional intelligence is that it focuses on the technologies of today as well as those of the future that can be used to help judge credit risk. Credit fraud has been a major concern as technology evolves. Verification services and background checks are becoming more commonplace in helping to confirm that an individual is indeed who they say they are. Experian explains the various methods by saying, “Some additional informational elements emerging as useful in isolation (or, even better, as a factor among others in a holistic assessment of a consumer’s identity and risk profile) include these areas: IP address vs. physical address comparisons; device ID or fingerprinting; and biometrics (such as voice verification).” All of the aforementioned tools can be used for verification as well as an additional means to evaluate a consumer’s credit risk. As our technology and data continue to grow additional intelligence will gain popularity and serve as an important tool used to help review a consumer’s credit.
Gumshoe Intelligence – my borrower has no history
New technology has provided some valuable tools for the independent auto dealer to use in accessing credit risk. There are several tried and true methods that may be even more accessible and equally reliable for a local independent auto dealer. With a phone call, a dealer can verify employment, reported wages, length of employment, and housing expense. Using information confirmed with a phone call, a dealer can calculate a borrower’s DTI, make an independent credit decision and determine how this loan might sell to a bank or note buyer.
In conclusion; by using credit scoring, payment history, outstanding debt, length of credit history, additional intelligence, and gumshoe intelligence, an independent auto dealer can successfully assess an individual’s credit risk. It is important to note that in today’s times businesses should not rely on just one or two credit assessment methods; they would be wise to use them all. Ultimately these methods only make the business more profitable in the long run by maximizing the value of the loan portfolio and minimizing loan loss exposure upfront.