What Are Credit Criteria?
Trade criteria are the factors used by lenders to determine whether or not to approve a new loan. Although individual lenders might vary in the specific criteria they consider, most lenders converge around a set of five basic factors.
- Credit criteria are the factors used when assessing the strength of a new credit application.
- Most banks use a similar set of criteria to estimate the creditworthiness of the borrower.
- Some factors, such as ethnicity or religious beliefs, are prohibited by law from being considered in such decisions.
How Credit Criteria Work
The five most commonly used credit criteria are as follows:
These factors are fed into a credit scoring model, which applies weights to these factors in order to produce a comprehensive credit score for the borrower. Based on this score, the lender will either reject or approve the loan, and may also use the score to inform the specific loan terms they offer.
Although they may seem complex, the underlying intent of the credit criteria is simply to estimate the creditworthiness of the borrower. Applicants with a history of regular and complete payments and relatively infrequent credit inquiries will be favored. Similarly, most credit scoring models will prefer applicants who have remained well within their overall credit limits, and who have a long track record of responsibly maintained accounts. By contrast, applicants who have recently opened several new credit accounts, or who have missed payments in the past, will be scored less favorably by most credit models.
Additional Due Diligence
Beyond looking at these common credit criteria, lenders will sometimes also perform additional due diligence. In doing so, they are often guided by what has become known as the Five Cs of Credit, which is a colloquial framework for assessing a borrower’s creditworthiness. These consist of the borrower’s character, capacity, collateral, capital, and the conditions of their loans.
Ultimately, a lender is free to consider any or all of these factors when deciding whether to approve a loan. However, it is important to note that, due to rights legislation such as the Equal Credit Opportunity Act (ECOA), identity factors, such as the borrower’s race, ethnicity, or religious beliefs, cannot be considered when making credit-granting decisions.
Example of Credit Criteria
Sal is applying for a personal line of credit at an American bank. As a recent immigrant, he is eager to build his personal credit history in order to qualify for a mortgage at a later time.
In preparing his application, Sal begins by researching the factors that are important to the bank when assessing new credit applicants. He notes that most banks prioritize factors such as the reliability with which the borrower has made their payments in the past, the overall level of credit used by the borrower, and the length of the time for which the applicant has been a credit customer.
Thankfully, Sal had planned ahead to ensure that his applicant would be as strong as possible. When he first arrived in America five years ago, he signed on as the authorized user of his American cousin’s credit card. By ensuring that he and his cousin paid their credit card in full each month, Sal was able to demonstrate a reliable payment history while also building a track record as a credit customer.
Since then, Sal was able to obtain his own credit card and has been careful to stay within his credit limit while continuing to make his payments in full and on time. By understanding and planning ahead, Sal is cautiously optimistic that his loan application will be accepted by the bank, due to the strengths of his credit criteria.