Lenders evaluate three major criteria when considering an extension of credit: the consumer’s capacity to pay, any collateral offered as security, and his or her character. Although the lender’s representative may not know the borrower personally, all of the information to make those determinations are included in the credit report and accounted for by the credit score. Restricting lending activity to those with higher credit scores minimizes the overall risk potential faced by the lender.
- Capacity – this calculation of the amount of debt that the borrower can realistically pay back is based on income(s) and existing debt. Lenders also consider the borrower’s employment history and the likelihood of increased earnings. A borrower’s stable career and consistent earnings can merit an increase in the capacity calculation and improve his or her qualifications for the loan.
- Collateral – assets that a lender can seize in satisfaction of an unpaid debt are considered collateral, whether directly pledged as security for the loan or not by the borrower. Creditors can make a loan contingent upon the borrower depositing sufficient collateral to secure the debt, depending on the borrower’s credit history and the size of the loan. Even if the loan were made without a requirement for collateral, the lender can still file suit to compel the borrower to relinquish those assets as repayment for the defaulted loan.
- Character – several factors are assessed to determine the borrower’s financial character. Stability in employment and one’s residence are considered. Whether the consumer owns, rents or leases is important. Although the credit report cannot state the value of checking or savings accounts, having those accounts in good standing are signs of financial character.
The data models used by credit bureaus to calculate consumer credit scores factors in each of these lender requirements. Before credit is extended, lenders can pre-set limits, rates, and the term automatically based on the consumer’s credit score. Most major lenders have procedures in place to review those automated decisions, if circumstances suggest the need. Consumers can usually request a review of their credit report from major lenders to increase their credit limit or lower the interest rate.