With a budding business in his briefcase, a $67,000 salary as a stage technician, and a $3,800 car to his name, Stephen Sorensen thought he could make a case for getting a $4,000 loan for himself, despite a checkered credit history that included a personal bankruptcy. So he completed a loan application at a bank. Two weeks later he received a rejection letter. He wanted to plead his case, but try as he might, he couldn't get face time with a loan officer.
That's because of two practices in growing use at regional and national banks: credit scoring and automatic loan decisions, or what banks call "autodecisioning." Credit scoring, which has been around for years, is the process by which a computer calculates an applicant's creditworthiness, be it for a credit card or -- with increasing frequency -- a small-business loan. In autodecisions, a bank bases loan approvals or rejections solely on an applicant's credit score. The likelihood that a bank will use both automated processes to make a decision on your loan application is tied to the size of the loan you're requesting; the smaller the loan, the more likely the evaluation will be fully automated. (See "Sometimes Size Matters," below.) Most banks don't use autodecisions for loans greater than $100,000. If the request exceeds that figure, a loan officer or bank committee makes the decision, employing the credit score as one of several factors.
Relationship-based, "handshake" lending persists at community banks. And officers at large banks insist that using autodecisions doesn't keep them from providing personal service to small-business customers. Still, according to Loretta Mester, director of research at the Federal Reserve Bank of Philadelphia, the use of credit scores in lending decisions is rising -- and is likely to continue to rise -- with industry consolidation, as large banks that need automated processes to handle their heavy loan volumes continue to acquire small banks. More small banks, she anticipates, will adopt scoring as the software that the process requires becomes less expensive.
The spread of automatic loan decisions is bad news if, like Sorensen, you feel you are a better risk than you look to be on paper. But the automated process has its merits. It allows many lenders to offer loan decisions by phone or online within 24 hours. And some credit-scoring advocates believe that minimizing the human element makes lending decisions less subject to racism and sexism.
Although most banks use scores calculated by credit bureaus to evaluate loan applications, the emphasis each bank puts on the scores varies. So there is no magic bullet for acing a credit-scored application. Before you apply, however, you should examine both your personal and business credit reports for negative signs and inaccuracies. Some banks use autodecisions for all loans under a certain amount, but plenty do not. So an imperfect report won't necessarily doom your loan application. And if you are rejected, at least you'll learn about it quickly. Just don't expect an in-person explanation.
Sometimes Size Matters
When you're seeking a loan, do you prefer "handshake" lending to an automated loan process? Then go to a small community bank. Generally speaking, the larger the bank, the larger the loan size for which approvals are based mostly on a computerized evaluation of your creditworthiness.
|Size in assets||Upper loan limit|
|First Security Bank, Bozeman, Mont.||$247 million||Doesn't credit score|
|Centennial Bank, Portland, Oreg.||$849 million||$35,000|
|Hibernia Corp., New Orleans||$16.7 billion||$50,000|
|Bank One Corp., Chicago||$265 billion||$100,000|
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