Why Does a Business Loan Result in Credit Loss?
Credit can be a fickle area and sometimes the slightest things can make it fluctuate. Getting a business loan isn’t slight and it will definitely change a credit score. In fact, it may decrease a consumer’s credit score. Here are three reasons why a business loan can cause consumers to have a lowered credit score and why it can make an impact on a bank’s credit losses.
The reason a hard inquiry will drop your credit score is because it looks like a risk to lenders. They may wonder why you need a loan and if you’re able to pay it back on time. It seems a little pre-judgmental when you’ve just applied for credit, but any need for new credit comes across as a weakness at first. Of course, your score will only drop by a few points and if you have excellent credit, it may not affect it at all. However, a lot of new inquiries at once will drop your score by a few points each, leading to a significant credit loss.
On January 1st, 2020, a new Current Expected Credit Losses (CECL) standard (ASC 326) was put into place. Experts warn that the adoption of CECL will change Q&E adjustments. This is because the changes under CECL are significant and include qualitative changes to inputs used to predict credit losses. While this has more to do with how banks will assess lenders for loans, in the long run it can impact how many points your score would decrease simply for taking out a loan. It can also impact other areas of credit such as qualifications and interest rates.
High Loan Balance
High loan balances contribute to a lowered credit score, even if you make your payments on time. This is because it raises your debt-to-income ratio which gives the appearance that you may not manage money well. If you have a good credit history, this may not affect you too much but if not, this can lead to a less-than-trustworthy credit report.
Credit and all the policies that go with it are very complex. Not only does it affect consumers who take out loans, but it affects banks who must keep loan loss reserves as protection from customers who default on loans. Since loan loss provision estimates are now being reformulated under the new CECL, banks must now make a more in-depth analysis of the credit worthiness of people or businesses seeking credit in order to buffer the banks’ credit losses. This will lead to lowered credit scores for loans around the board.