Sound credit decisions are based upon the 3 Legged Stool custom. Character, Capacity & Collateral - it is just that simple, yet that complex. As in a three legged stool, the stronger each leg is, the more solid and reliable it will be.
In a nutshell ...
Acceptable Character is basically a detailed analysis of the credit report of an applicant, along with their stability of residence and employment. On balance, there is a scale here - from top-notch gold plated all the way down to lousy. The further away from lousy, the stronger that leg of the stool is. This is considered the most important leg by many long experienced credit grantors.
An applicant Capacity to good lending decisions is critical, as it is essential any new customer has the ability to repay their debts. The Character leg's strength tells us their willingness to take care of their obligations in an acceptable manner. This Capacity leg however, measures their capacity - their ability - can they afford it? This leg of the stool needs the support of a likely reliable and steady available future income stream so the customer has the funds to make timely payment.
The Collateral which secures the transaction is the third leg of this three legged stool. Obviously, the more security which collateralizes the loan the better, and the stronger the stool will be. This is thought of by many however, as the least important leg of the stool, as it can lose value and is not always of satisfactory quality, or accessible upon default.
With two sturdy legs for our stool, with only one weaker, even though not ideal, is still an adequate formula. Two of the legs weakened is generally a recipe for disaster. Having all three of the legs fragile at origination, barring a miracle, is most certainly a future loss.
An ingredient missing from the training regimen of most employers in our industry these days, is teaching this concept to all personnel. Sure, processors may get a small bit of it via osmosis; naturally underwriters and institutional investors should all be intimately familiar with this sort of thinking; yet it is our observation even many of them are not. Unfortunately mainstream Loan Officers don't have the first clue what it's all about, all too regularly. They see themselves as sales experts, closers, and regrettably not loan analysts. Yet those very LOs are the face of our industry to nearly everybody outside the business!
It's time for them to understand what a good loan is.
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