Beginning our series "Industry Checks & Balances" – at it's core are reliable credit decisions. In an era where most on the origination side know little about how sound credit decisions are arrived at; due to the advent of credit scores and matrix's of scores vs LTV vs DTI ratios, this issue is critical for the long term survival of individual practitioners and the industry as a whole. We'll explore most of the necessary 'checks & balances' over the next several months.
Sound credit decisions are based upon the 3 Legged Stool custom – NOT ON A COMPUTERIZED CREDIT SCORE ALONE. Character, Capacity & Collateral – it is just that simple, yet that complex. As in a three legged stool, the stronger each leg is, the more solid and reliable it will be.
In a nutshell …
Acceptable Character is basically a detailed analysis of the credit report of an applicant, along with their stability of residence and employment. On balance, there is a scale here – from top-notch gold plated all the way down to lousy. The further away from lousy, the stronger that leg of the stool is. And, this one is considered the most important leg by many long experienced credit grants (like me BTW).
An applicant's (proven verified long-term historically stable) Capacity to good lending decisions is critical, as it is essential any new customer has the ability to repay their debts. The Character leg's strength tells us their willingness to take care of their obligations in an acceptable manner. This Capacity leg however, measures their capacity – their ability – can they afford it? This leg of the stool needs the support of a reasonably reliable and steady available future income stream so the customer has the funds to make timely payment.
The Collateral which secures the transaction is the third leg of this three legged stool. Obviously, the more security which collateralizes the loan the better, and the stronger the stool will be. This is thought of by many however, as the least important leg of the stool, as it can lose value and is not always of satisfactory quality / marketability, or accessible, upon default.
With two sturdy legs for our stool, with only one maker, even though not ideal, is still an adequate formula for a more conservative loan approval. Two of the legs weakened is generally a recipe for disaster. Having all three of the legs fragile at origin, barring a miracle, is most certainly a future loss.
An ingredient missing from the recent training regimen of most employers in our industry, is teaching this concept to all personnel. Sure, processors may get a small bit of it via osmosis; naturally underwriters and institutional investors should all intimately familiar with this sort of thinking; yet it is our observation far too many of them are not. All too regularly, unfortunately mainstream Loan Officers do not have the first clue what it's all about. They see themselves as sales experts – closers, and regretably not loan analysts as they should be. Yet those very LOs are the face of our industry to nearly everyone outside the business!
It's time for them and everyone else to understand what a good loan is.