Understanding Loan Ratings

Financing a new house or car involves a credit check to ensure a borrower is a worthy risk for the stated amount of money. Banks also undergo scrutiny for their part in loan approvals, as regulations and investors must monitor that financial impact and security of the community being serviced by the lender. When a bank’s loan portfolio is examined, several loan classifications identify the nature of the lending process. A pass loan rating is the highest standard, and a loss rating is the lowest category.

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Five Loan Types

There are a total of five loan ratings: pass, special mention, substandard, doubtful and loss. For a bank to remain profitable and in good financial health, higher rate loans are best. Receiving a pass rating indicates that the borrower is in good standing with the terms of the loan contracts and there is very little risk of default. Special mention isn’t technically a loan category, but rather a flag of potential areas of concern which warrant further attention by management.

With a substandard loan rating, there is an indication of severe weakness with the ability to liquidize the debt. Often these indicate the worth of the collateral is not equal to the original loan amount, and the bank may sustain some loss is default occurs. Having a loan rated as doubtful means the loan maintains the same qualifications as substandard, but increased weaknesses make liquidations or collection improbable and highly questionable.

When a loan receives a loss rating, the value is considered uncollectable and maintain its status as a bank asset is no longer warranted. The loan isn’t necessarily a write-off, as long term collection may still be possible. There is simply no immediate financial prudence to keeping the loan.

As you work with a bank to finance your purchases, it can be easy to feel frustration at all the paperwork and hoops to jump through. Keep in mind that lenders have their own accountability standards when signing the contract.