You’ve probably seen the ads about credit scores on television and on the Web. While annoying, these ads all have one thing in common: They never answer the question “What is a credit score?”
Loosely translated, credit scores are calculated from a mathematical equation that helps predict whether you’ll repay a loan. Credit scores have been used routinely in the consumer arena for car and home loans for years. And now, their use in agricultural lending is on the upswing, says Mike Swan,
Lenders believe credit scores provide a good guide to estimating future risk. That’s because your credit score is earned from your past financial performance. When combined with other financial tools, credit scores also can help determine the interest rate for a loan.
However, unlike a touchdown — which is always six points no matter where it’s scored — credit scores often carry a different weight with different lending institutions. Not only do you need to know your score, but also how it will be used and its potential impact on your finances. So, here are the answers to several commonly asked questions about credit scores and the bearing they will have on your dairy-farm business.
Q. What are credit scores?
Credit scores are based on a proprietary mathematical equation that helps estimate your future risk based on the data contained in your credit report. Lenders use credit scores to determine your probability of repaying a loan, explains Swan.
These scores attempt to remove subjectivity from the loan process. They do not put any emphasis on character or personal information like age, salary, where you live or race. Instead, they make an objective measure based solely on financial data.
In general, the higher your credit score, the lower the credit risk to your lender, and the greater your chances of getting a loan. Often, it means getting a lower interest rate as well.
Q. What data are used to determine a credit score?
The three major credit bureaus — Equifax, Experian and TransUnion — use three-digit Fair Isaac Corporation (FICO) scores to determine your personal, or consumer, credit rating. Scores may differ between the bureaus because the credit history each agency has on you may be different. Scores range from 300 to 850.
However, most financial institutions use their own credit evaluation process when you apply for a business loan, which may or may not include FICO scores. And dairy lenders are no exception.
For instance, Citizen’s State Bank of Loyal, Loyal, Wis., evaluates loans based on a dairy’s current and intermediate equity compared to current and intermediate assets, ownership equity, cash flow and first lien collateral value to debt. Loan applicants receive a bank-based credit score based on how they finish in these categories.
“For our commercial (ag) customers, a score of 400 or more shows no weakness; 340 to 400 points is ‘normal’; 280 to 340 points shows some weakness, and those 280 points or less indicate a potential problem,” says Gary Sipiorski, president of Citizen’s State Bank of Loyal. These scores are not the same as FICO scores.
Meanwhile, Anthony DeRose, executive vice president of Wells Fargo Bank in
In addition, Wells Fargo lenders evaluate dairy loan applications on farm-leverage levels, cost of milk production per hundredweight, the percentage of long-term versus short-term debt, as well as the dairy’s borrowing capacity in relation to the collateral with which it will secure the loan.
Other lending institutions use still different loan evaluation means. “We have different ways to analyze loans, depending on their size,” says Mike Zook, lending services officer with First Farm Credit in
“Most producers are surprised that we check their credit score,” he says. “They know that a car dealer checks the score when they go for a car loan, but they don’t think about it in terms of the commercial agriculture lender.”
Q. Why do lenders use credit scores?
Lenders use credit scores because they provide an objective means to evaluate loan applications. They can help lenders evaluate whether your business can make money with someone else’s money.
“Not once when we go through our scoring system do we consider who the applicant is,” says Sipiorski. “It’s completely objective, based only on the numbers.” Personalities don’t enter into the equation. But your past financial perfomance is considered.
Q. Why are credit scores being used more often?
Credit score use has increased significantly for several reasons. First, basic ag lending has changed considerably since the early 1980s when many loans were made solely on the information on a dairy’s balance sheet, explains Sipiorski.
Secondly, credit score use has increased because of the explosion in available credit, whether through low- or no-interest credit cards, equipment dealers and even feed suppliers.
And third, credit scores can be a useful tool as lenders try to be the fastest and best at what they do, says Zook. “It is a verification tool that allows us to give a better deal to people with the best credit.” While probably never an exclusive tool to evaluate loans, credit scores do allow lenders to speed up the process and cut through red tape.
Q. Does my personal credit count toward my dairy’s credit score?
It depends. If your business is a sole proprietorship, then your personal credit score applies to your dairy business. And lenders will ask to see individual balance sheets for these dairies, and possibly FICO scores.
However, FICO scores are not available for business structures, like limited liability corporations. Therefore, the business will be judged on its financial performance using the factors listed earlier or others specified by your lending institution. But, it is not unusual for lenders to ask to see personal credit scores for business partners as part of the loan process, since these results may have an impact on the overall financial health or future direction of the business.
Q. Can I change my score?
Yes. You can learn the two main avenues you can use to improve your score in the December issue of Dairy Herd Management.