A secured loan is such because you have given the lender evidence that they will get the money they are lending you back. Generally, if the borrower makes payments and stays in good standing, the loan will remain an unclassified loan. If the borrower fails to make timely payments, the bank or lender may decide to make it a classified loan.
For instance, in a mortgage, the lender will look at how much value a property has in order to determine how big a loan you can get. They will use the rental income ability of that property as further proof that they will be able to get their money back.
A very common type of classified loan is real estate. In the event that the borrower loses a job or is facing other circumstances that make it impossible for the borrower to make the payments on the loan, the bank may decide to turn the loan into a classified loan so they can continue to recover interest on the loan while they seek to recover what little they can of their investment.
What are the different loan classifications used by lenders?
Lenders classify loans when they meet a standard established by the Uniform Retail Credit Classification and Account Management Policy.
A loan can be classified as special mention status when the borrower is experiencing issues with their income or credit score. While there is not a sudden drop in income or credit, the loan is still at risk for default. This can typically be seen when the applicant has fallen behind on a payment plan in their previous loan.
When lenders classify a loan, they use three categories:
- Substandard: Loans are generally classified as substandard when the borrower is deemed to be at risk of defaulting on payments. This classification is used to indicate when the lender may expect to experience some loss, should conditions not improve.
- Doubtful: Doubtful loans are those where the lender is unlikely to collect the full amount. This is less of a warning than for substandard loans, and more of an acknowledgment that a part of the loan will not be repaid.
- Loss: When classified as such, loans deemed as losses mean that the bank has decided that it would be more beneficial to write off the loan or asset, rather than go through potential recovery attempts, such as liquidation or repossession.
How does a lender determine whether a loan is unclassified?
Classified loans are dynamic in nature and are variable according to investor preferences. Every borrower is assigned a credit score. Borrowers who have a score equal to or higher than the threshold score set by each investor’s lender will have their loan classified as an investment-grade loan.
Investment grade loans are defined as those that have no known risk of default and include loans that have become classified under a registered private lending program.
An unclassified loan denotes the bank expects that the loan will be paid in full and on time and doesn’t show any elevated risk factors.
Do unclassified loans affect your credit score or finances?
On the other hand, a private loan falls under the category of a secured loan, which requires you to possess some form of security in order to secure the loan. For those who do not own property, a car, or furniture that can be used as collateral, it is best to go for an unclassified loan.
Other ways for a loan to become classified include a special situation, such as a substantial reduction in the value of collateral, or the inability to verify information provided by the borrower.
What can you do to prevent your loan from being classified?
There is no shame in a loan becoming classified. It simply means that something has changed about your financial status – like a loss of income or a change in credit score. These can be indicators that you are more of a risk than you initially were and may result in the bank classifying the loan.
Banks typically classify a loan as delinquent after 90 days of non-payment. At that point, the loan is considered to be at risk of default, and the bank may take steps to secure the debt, such as by requiring collateral.
Unclassified loans — The bottom line
It’s important to remember that just because a loan goes from unclassified to classified, it doesn’t mean that you’re necessarily at risk of default. There are many factors that can affect this metric, which banks use to measure potential risk. However, in most cases, an unclassified loan becomes classified as the result of missed payments. So be sure to stay current on your payments and avoid classification.