A classified loan, also called a criticized loan, is a loan that has been recognized by the issuer as in danger of defaulting. Financial institutions label loans as classified to monitor potential loss, and there are many ways a borrower’s loan may be deemed as risky to the bank.
Missed Payments or Decreased Salary
Outstanding payments and interest will evidently cause the lender to become cautious toward the borrower because they are showing signs that the loan may have to be written off. A less obvious reason a loan may become classified is if the borrower’s salary suddenly decreases significantly or, in the case of unemployment, completely stops. The borrower is then considered to be risky because they have a lower ratio of debt to income.
Decline in Credit
Another common reason for issuers to label loans as criticized loans is a sudden drop in credit. If a borrower’s credit score decreases by 100 or more points, the bank will look at the account to determine what caused the decline and continue to monitor it, especially if the drop was due to reasons that otherwise make the borrower risky, such as a lower debt to income ratio.
Lender Change
Loans will also be classified so that they can be monitored in the event of a bank merger or the loan is otherwise sold to another institution. Different banks have different standards that may be stricter, and if the loan changes hands to a stricter institution that may not have approved the loan in the first place, then it will be continuously and closely monitored.
Classified loans are helpful for institutions to take precautions for potential loss and prevent such risk in the future, but they can be an annoyance for borrowers. If you’re a borrower whose loan has been classified, you should carefully monitor your credit and your status with your lender to prevent damage to your credit report.