Your credit score can be the most influential factor to get you through a Lender’s door when making a decision to extend credit, and it certainly will determine the price a borrower will have to pay. Understanding what impacts your score and how to best manage it may dictate the future borrowing options available to your Law Firm. Regardless of your current credit standing, having an understanding of how you can maintain or improve it is critical knowledge that will place the power to control your law firm’s financial future firmly in your hands.
Attorneys have more odds stacked against their credit than possibly any other small business owner. Their personal credit is intertwined with the credit performance of their law firm; the mortgage on their home, their car payments and personal credit card history is reported alongside their firm’s business card history, and so on and so forth. Not only do attorneys have to strike the balance between their personal and professional lives, but law firms with multiple partners must communicate to understand how each of their partners’ credit may impact the firm as well. Given the sensitive nature of credit management and the dynamic between partners, maintaining the financial health of a law firm is no easy task. Even as a lender reviewing hundreds of credit profiles day in and day out, Case Funding still runs across surprising credit scenarios from attorneys – and sometimes an even more surprising lack of general know-how for keeping stellar credit. Here are some FICO – friendly basics for keeping up a credit score that may help you get the loan you need when you really need it:
Why do lenders use FICO scores in a loan decision, how does it help me?
Before the use of FICO scores, a lender’s underwriters would pour over financial documents in order to assess a loan request. Each reviewer had their own special formula for risk, and the loan approval process was often rife with debate and lengthy. Through the use of a standardized credit rating system, lenders can now pass loan applications through the process much more quickly. Although many lenders will still determine their own criteria for approval that may require other information over and above your FICO score, it is more often than not a key factor in the decision process. Through the use of FICO scores, borrowers are able to:
Get loans faster
Show that they have rectified past mistakes
Have access to greater amounts of credit
How does Case Funding Inc. use FICO score when considering an attorney loan application?
Case Funding Inc. has worked to reward attorneys who have maintained great credit. Our Attorney Credit Express (ACE) loan helps law firms with great credit expedite their financing request through low documentation requests and a streamlined approval process which can effectively infuse a law firm with up to $50K in cash within a matter of days. Significantly higher loan amounts are available to attorneys who submit additional financial information along with their FICO score.
However, the very nature of a contingency-fee based law practice can make maintaining spotless credit a notoriously difficult task for many law firm owners. With an astute understanding of the practice of personal injury law, Case Funding recognizes this and is able to help law firm’s compensate for less than perfect credit by raising the emphasis on other elements that impact a financing decision. This flexibility unfound in the traditional bank financing process is what allows legal finance lenders to fill the gap for personal injury law firms.
“The FICO score is definitely something we look at in evaluating a loan, but we are very aware that it is just a snap shot. Attorneys should be reassured that Case Funding will take everything in their credit profile into account.” Says Jeff Livingston, VP of Commercial Lending.
What is a FICO score?
The gold standard for lenders is the FICO score, introduced in 1989 by Fair, Isaac and Company, and relied upon by the three major credit reporting agencies, Experian, Equifax and TransUnion. Although each of these companies use FICO, each has its own variant and your score will vary depending which company’s credit bureau is “pulled”.
The FICO score is representative of your credit risk based upon your current and historical credit related activities. A FICO score allows lenders to quickly estimate your ability to pay back a given amount based on standardized and accepted criteria. FICO scores range from 300 – 850, and although each lender has its own lending criteria, generally, scores above 700 are considered “prime” and those below about 650 signal potential credit issues to most lenders.
How is the FICO Score Calculated?
Fair Isaac does not share its secret formula but your FICO score will take into account only the information collected by the respective rating agency and listed in your consumer credit report. Each credit reporting agency may keep different information on their reports, so your FICO score is likely to vary from agency to agency. Your credit data can be provided by any institution that has extended credit to you, including: your credit cards (and any business credit cards you have personally guaranteed for your law firm), retail accounts, installment loans, finance company accounts, and mortgages. In addition, bankruptcies, liens, foreclosures, wage attachments, lawsuits and judgments will also be listed.
Your FICO score is calculated by comparing the positive and negative events across 5 categories listed on your credit report and weighted by characteristics specific to each category. These are:
1. Payment History – A common misconception about payment history review is that one must have just a few accounts with a perfect payment history in order to achieve a great FICO score. In fact, what is more telling to lenders is that you demonstrate responsible management and the ability to use a substantial amount of credit well over time. A few late payments here and there will be far less glaring to an individual with a history of managing a large amount of credit than it would for someone managing only a small amount. Even having a past with a low number of minor delinquencies may not adversely affect your score if you have been able to establish and maintain a good track record. Key characteristics that will be weighted in your payment history are: amount, days late (30, 60 or 90), recency, public record events (bankruptcies, liens, etc.)
2. Amounts Owed – Your credit utilization ratio (debt/available credit) is a major indicator of your ability to manage credit. This is not necessarily a measure of quantity as it is a measure of financial health quality, i.e. having credit accounts open with a balance owed is not necessarily a red flag. A borrower who is using $8K of a $10K available aggregated credit allowance will appear more overextended than a borrower who owes $8K on a $24K credit allowance (80% versus 33%). This doesn’t mean you should accept every credit card offer that arrives at your doorstep in order to increase your available credit, those strategies have notoriously backfired on small businesses (see our guide on Credit Cards for attorneys). This also means the recency of an installment loan will have a great impact on your FICO score, the more you have paid down on the loan (the older it is) the more of a positive impact it will have on your FICO score. Thus, it is important to balance the timing of your personal and law firm financial events; e.g. it may be difficult for you to secure a litigation loan for your Law Firm a month after you take out a mortgage on your new home. Key characteristics that will be weighted in your Amounts Owed are: Total credit extended, total current debt
3. Length of History – Again, the FICO score seeks to sum up your history of responsible credit usage, so generally those who have more of a positive history to show will be rewarded. However, your age, time in business or time using credit do not automatically reward or penalize your score. The FICO score will consider the age of your oldest account, the age of your newest account, and the average of all your accounts. A recent rush for credit could raise a red flag that you are headed for troubled waters. Conversely, a smooth increase of accounts and/or available credit while maintaining relationships with initial lenders is a good sign that you will manage future funds diligently. Key characteristics that will be weighted in your Length of History are: age of your oldest account, age of your newest account, and the average of all your accounts.
4. New Credit – Lenders want to know what you have been doing recently. They especially want to know if you have been displaying behavior that might tell them you are desperate for cash and a potentially high-risk borrower. “We’ve seen a number of law firms try to card hop to float through hard times, but you are really at the credit card company’s mercy when it comes to business credit cards. If they decide you’re exhibiting too much risky behavior, they may cut down your limit without notice, and that could have brutal ramifications for your FICO score” says Leon Branam, SVP of Case Funding.
Unlike traditional banks or credit card companies, Case Funding is able to offer financing to law firms based on factors other than just FICO. Case Funding considers the quality and size of a firm’s contingency case load, the net worth of the principals of the law firm and track record generating fees, as well as FICO.If you’ve had a checkered past, Lenders will want to see that you’ve reestablished good credit management recently in order to consider you for a loan. The FICO score considers how many new credit accounts you’ve opened recently, how many lenders have made authorized inquiries into your credit record, and the diversity (by credit type) those accounts and inquiries have been for. The FICO algorithm has been uniquely tailored to distinguish between ‘rate shopping’ behavior and risky borrowing. For example, applying to several mortgage lenders within a short period of time will not be counted against your credit. Accepting a few new credit cards, leasing a car, and applying for a litigation loan within a short period would be a red flag. Key characteristics that will be weighted in your New Credit Review are: # of new accounts, diversity of new accounts, # of credit inquiries, time since last credit inquiry, correction of past behaviors on new accounts.
5. Types of Accounts in Use – The FICO score seeks to determine whether or not you have experience with revolving credit and installment credit and how many of each type you have. For this reason, it is not a great idea to open an account without planning to use it. The FICO score rewards only a demonstrated history, and even if you close the account, it will remain part of your credit profile for some time. Key characteristics that will be weighted in the Types of Accounts in Use are: # of accounts, Revolving or Installment credit use mix.
I didn’t ask a lender to make a credit inquiry, but it looks like they have. Do unwanted inquiries count against my FICO score?
The FICO score will not count inquiries from you to review your score, a credit reporting agency, or inquiries made of a lenders own volition in order to ‘pre-approve’ you. Inquiries you initiate will be counted against your score, however ‘rate shopping’ will not be counted against you as long as the inquiries are made for the same type of credit (a loan for example) and occur within a 14-day window. However, note that many inquires will do you damage. Fair Isaac states that in its experience, borrowers with 6 or more inquiries listed on their report are more than 8 times more likely to declare bankruptcy!
The Bottom Line
Lenders who adhere to the ‘relationship’ philosophy of business, also want to make sure the money you borrow is a good decision for the success of your Law Firm – they don’t want to see you go out of business with a bad borrowing decision. By examining your FICO score and other financial information, lenders are able to determine if extending you credit is a good idea for everybody. While credit score management isn’t easy – the time and effort is well worth the rewards in the long run.