A credit report is a collection of detailed information compiled by a credit bureau to aid in the evaluation of a lender's decisions regarding making loans to the individuals about whom the reports are compiled. The type of information contained in these reports includes personal information, credit history and records of previous credit defaults. By outsourcing the collection of this information to a credit reporting bureau, lenders receive many benefits.
Combining Many Sources of Financial Information
One benefit of a credit report to a lender is simply the ability to turn to one source for a collection of varied types of information. Rather than being forced to inquire into a potential borrower's potentially extensive credit history, a lender can outsource this task to a credit reporting bureau, thereby freeing up resources to focus on other activities.
Evaluating the Likelihood of Default
One of the principal uses of a credit report is to aid a lender in evaluating the likelihood that a potential borrower will default on his loan. A previous declaration of bankruptcy, for example, would likely be seen as evidence of the riskiness of a particular loan. Lenders benefit from this information because they will be less likely to lend money that might never be repaid.
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Evaluating Payment History
While not quite as serious as a total default, the risk of late interest payments is also an important concern for lenders. Just as credit reports can help determined the likelihood of a total default on a loan, they can also help determine the likelihood that a borrower may be late making payments. Late payments are a problem for lenders even if they ultimately receive their money because it can interrupt their cash flow and often leads to additional costs of collection.
Ability to More Accurately Price Risk
By helping to evaluate the chances of default and late payments, credit reports give lenders an additional tool for pricing the risk inherent in a particular loan. This not only benefits the lender, but also other borrowers. The greater the uncertainty of loans in general, the more the cost of that uncertainty must be spread amongst many borrowers. If, however, the source of that risk can be determined, the risky borrowers can be made to pay for their share of the risk through higher interest rates.
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