By John Ulzheimer
If you’ve been following the movement of interest rates on mortgages and auto loans, they’re very low. In fact, interest rates on mortgages and auto loans are close to historic lows. This means if you’re in the market to take out a secured loan, where you pledge the collateral to the lender, you can get some fantastic deals.
For many consumers the process of taking out a loan may seem very simple. You fill out some paperwork, wait a few days, and then you find out whether or not you’ve been approved. But what happens on the lender’s end after you click “Submit” on your loan application? Certainly, the process isn’t as simple as it may seem to the applicant. In fact, it’s actually pretty complicated. So what does happen on the “back end” when you apply for a loan?
Step 1 – The Application
Applying for a loan is really the only part of the process where the consumer has direct involvement. A consumer either goes to a mortgage broker, auto dealership, their credit union, or applies online via a lender’s website. What all of these options have in common is a formal request by a consumer to borrow money for the purpose of either buying a large-ticket asset, like a house or car, or otherwise plans to use the money for another reason, like paying off credit card debt.
As it pertains to credit, when you fill out and submit an application you’re providing what is referred to in the Fair Credit Reporting Act as “Permissible Purpose” to the lender. Permissible Purpose is a legal term that indicates the lender and the credit bureaus have a legal right to obtain and provide your credit report or credit reports in response to your application.
Step 2 – Risk Assessment
Once you’ve formally applied and given the lender legal permission to access your credit reports and credit scores, they will do so. This is commonly referred to as a credit “inquiry.” Most lenders have relationships with one, two or all three of the credit reporting companies or an authorized reseller of their credit report information and they will “pull” your information from one or more of those companies.
For clarity, do not assume the only thing lenders care about is the quality of your credit reports and credit scores. Lenders will also consider things like your debt-to-income ratios, your employment status, the loan-to-value ratios for secured loans, and the information that appears on your applications.
Step 3 – The Decision
Once the lender has procured your credit reports, scores, and the other information used for risk assessment, this collective of information is juxtaposed against the lender’s decision criteria. This is the point in the process where the lender decides whether or not to approve your application for a loan.
If you meet all of the lender’s decision criteria, which includes a great amount of credit specific criteria, then you will be approved. If you do not meet the lender’s decision criteria, you will be denied.
If your loan application is denied and the decision was based on your credit information, the lender is required to send you what’s formally referred to as a Notice of Adverse Action. Most people simply refer to these notices as denial letters. This letter will advise you of the lender’s decision and also provide a great deal of information about your credit reports, credit scores, and your rights. If, however, your application has been approved then you will move on to Step 4.
Step 4 – Funding the Loan
If you’ve been approved then the lender will communicate that to you, likely within a few hours or days. If you’ve applied for an auto loan, you may be able to drive away in your new car within a few hours. If you’ve been approved for a mortgage loan, the process of funding may take a few weeks.
For mortgage loans you will go through a process called “closing.” This is generally, but not always, performed by a real estate attorney. The closing attorney will meet with the buyers and sellers of a home and collect signatures on important documents from each side. The closing attorney will also collect funds from the bank and possibly the buyer. In essence the closing attorney makes sure the process is formalized and everyone either pays or gets paid appropriately.
Step 5 – You’re Now a Borrower
Once the closing of a loan has taken place, regardless of the loan type, the consumer formally becomes a borrower, obligor, co-obligor, or a debtor. These terms all mean the same thing, which is that you now owe money to some company. That company is referred to as your lender or creditor.
There are a variety of different types of lenders. Banks, credit unions, finance companies, and credit card issuers are all considered lenders. You can take out loans from most, if not all, lenders. Even some companies that are traditionally recognized as credit card issuers offer loans. Discover and American Express are two examples of companies that are more commonly associated with credit cards but that also offer loans.
Step 6 – The Furnishing of Data to Credit Reporting Companies
Many, if not most, lenders will begin to report your loan to the credit reporting companies within a few weeks or months after your loan is approved. This process is formally referred to in the Fair Credit Reporting Act as “furnishing.” As in, your lender will furnish information about your loan to the credit reporting companies, Equifax, Experian, and Trans Union (“CRCs”).
The information furnished by your lender to the CRCs will include data attributes such as the date your account was opened, the original loan amount, the balance, and your payment history. And, if you’ve missed payments or have defaulted on the loan, that information will be furnished as well.
Most lenders will provide updated information to the CRCs once every month, although it can happen more or less frequent. This information is collected by the CRCs from thousands of companies, which can then be aggregated with other information about you into what’s commonly referred to a credit report.
You have the right to check your credit report once every 12 months from the major CRCs via the website www.annualcreditreport.com. The CRCs announced in April 2020 that they would allow consumers free weekly access to their credit reports through the same website through April 2021.
Step 7 – The Scoring of Your Data
Once information about your loan makes its way to the CRCs, that information becomes scorable by any of the commonly used credit scoring models used by lenders and other types of companies. The process occurs when the CRCs compile the information associated with you in their systems and applies a scoring model to the data. This is commonly and informally referred to as “calculating your credit score.”
This process can occur for a variety of reasons. For example, if you apply for another loan, credit card or some other service the lender or service provider can request your credit score from the CRC. And, there are many websites that will provide a free credit score periodically for their registered users. You can find a list of those companies, here.
Step 8 – Paying Off Your Loan
There are a variety of ways to pay off your loan. You can make all of your scheduled monthly payments. You can make some of your monthly payments then make a lump sum payment to exhaust the remaining balance. Or, you can sell the collateral and use the proceeds to pay off the remaining loan amount. That’s what happens when you sell your house.
Once you loan has been paid off, the lender will update your credit reports to indicate the new zero balance. If the loan is in good standing it will remain on your credit reports for the next ten years. If the loan went into default, it will be removed no later than seven years from the date of the default.