A credit application is a document that formally requests an extension of credit from the lender to the borrower over a set agreed time period.
Credit applications can be made verbally, written, or even applied for online, so long as the loan application contains all the lender’s required information and fair treatment of all is offered.
These documents are used not only to secure credit for the borrower but also to protect the lender and ensure that those they extend credit to can make the agreed repayments and they won’t be left chasing outstanding debts.
In this post, we look at the importance of credit applications and why businesses introduce them as part of their credit control procedures.
What is a credit application?
Definition of credit application: A credit application is a binding (legal) contract between the borrower and the lender where one extends credit to the other based on the fact that this credit will be repaid over a set period of time and often at a higher amount due to interest fees added on.
Serving as a contractual agreement, the application will contain a request for personal and financial information to allow the lender to assess the borrower’s creditworthiness.
The information gathered at this stage can be crucial, especially if your customer defaults on payments and you have to begin the commercial debt recovery process, which can involve chase letters, the use of professional third-party debt collection teams, etc.
If a credit application is rejected, the borrower can ask for the reason why. In response, an adverse action letter will be issued explaining the reason behind the decision, i.e., the credit score was too low. The letter can also highlight where your credit is weak, providing borrowers with areas to work on.
Reasons why a credit application may be rejected include:
- Poor credit history
- High debt-to-income ratio
- Inadequate information has been provided.
Credit applications are used for:
- Trade credit
- Loans
- Credit cards
- Mortgages.
Reasons to have a credit application
Providing creditors with peace of mind, borrowers can answer all of the questions you require as well as provide all relevant documentation, which the lender can then use to make an informed decision on how safe or risky it is to offer the customer credit.
The information asked/required often includes:
- Trade references
- Banking references
- Name of the business
- Type of business entity
- Date business started
- Business address and contact details
Documentation that is often required as part of the credit application:
- Proof of identity
- Documentation of name change
- Income – payslips
- Bank statements (business credit)
- Credit reports (vital in providing the lender with information on how a borrower will handle their debt as credit reports show monthly credit payments over the past 7 years. This means any missed payments, or if a debt recovery agency has been involved with collections, it will be noted). Credit reports can also be used to check if the borrower has any outstanding credit so you can see the financial position clearly.
The lender must also include terms and conditions within the credit application, which should include:
- Cost of collection on default payments
- Interest added
- Credit limit
- Rights and obligations of the creditor
Importance of credit application
For the borrower:
- This is an important step in obtaining a loan or line of credit to help support your business.
- It can help with the future financial health of the business.
- Supports business growth.
- Helps with cash flow.
Note: Applying for a lot of credit in a short space of time or in quick succession can hurt your credit score and also give lenders the impression that you are in financial trouble and need the cash urgently.
For the lender:
- Obtaining credit applications can be invaluable to the financial health of your business. Helping you to decide on your customer’s creditworthiness and ability to repay their debt obligations.
- The credit application also tells you more about the customer, limiting your risk and preventing delayed payment.
- It helps to prevent write-offs and bad debt spiraling.
Small business debt
Businesses often rely heavily on trade credit to help them secure equipment and products, paying for these on credit until jobs have been completed and they themselves are paid.
However, we understand that there are elements of risk in this process, and sometimes customers do default on their repayments, and these can build up, negatively affecting your cash flow and ability as a business to grow.
This is where the importance of a robust credit application comes in—gathering as much information as possible to allow you to make the best and most informed decision for you based on what you are presented with.
At Direct Route, we work alongside in-house credit control teams to support credit processes and the collection procedures required for chasing outstanding debt, reducing risk and minimising late payment.
Call us on +447860 197476 to find out more.