By understanding and addressing background check best practices, lenders can navigate the process effectively, make informed lending decisions, and maintain compliance with applicable laws.

Background checks can be an important tool in business-purpose lending, providing lenders with critical information to make informed decisions about a borrower’s creditworthiness and character. These checks help lenders evaluate various aspects of a borrower’s financial history, business operations, and personal background. They can also provide a variety of other useful information such as criminal, legal, and regulatory history. However, it is important for lenders to exercise judgment when interpreting the information obtained from these checks, ensuring it is relevant to the borrower’s credit profileand does not result in any unintended bias in the lending decision.

Evaluating Background Checks

Lenders may consider several factors when assessing criminal background check results. Here are many of the flags that can show up, along with what lenders should consider when evaluating their impact on an underwriting decision.

Convictions. Considerations include status, timing, and severity.

• Status. First, only convictions should be evaluated in the context of a credit decision. Unsubstantiated allegations or charges without a guilty verdict should not be used to make lending decisions, because they could unfairly impact the borrower.
• Timing. The recentness of a conviction also should be considered. More recent convictions may indicate ongoing or unresolved legal issues that could affect the borrower’s ability to fulfill their financial obligations. Crimes committed further in the past may be less relevant, because individuals can rehabilitate and demonstrate improved responsibility over time.
• Severity. The seriousness of a crime should also be considered. Felonies typically (but not always) indicate a more serious crime than misdemeanors.

Financial crimes. Financial crimes, such as embezzlement, arson, or fraud relate to a borrower’s financial integrity and may pose a higher risk to lenders. These offenses may be given greater weight in the credit decision because they could indicate a higher potential for financial misconduct.

Bankruptcy. Another common red flag is a history of declaring bankruptcy. Bankruptcy indicates a borrower has faced severe financial difficulties in the past, potentially suggesting a higher risk of defaulting on future obligations.

Judgments. Multiple or large judgments against a borrower may also raise concerns for lenders. Judgments occur when a court orders an individual or business to repay a debt owed. The presence of multiple judgments may suggest a pattern of financial irresponsibility or an inability to meet financial obligations promptly as well as a willingness to litigate rather than repay creditors.

Fines and penalties. Adverse regulatory actions may also have a negative impact on a borrower’s creditworthiness. These actions may include sanctions, fines, or penalties imposed by regulatory authorities due to noncompliance, unethical practices, or other violations.

Liens. Unresolved tax liens may be another concern. Liens are imposed by tax authorities when an individual or business fails to pay their tax obligations. Lenders may view unresolved liens as a sign of financial instability and a potential encumbrance on the borrower’s assets. Such liens may undermine a borrower’s ability to repay loans.

No Rubber Stamps

Remember, it is crucial for lenders to maintain a balanced approach. Each borrower’s circumstances are unique, and the interpretation of background check information should be done judiciously. It is essential to consider the overall credit profile of the borrower, including factors such as their financial stability, credit history, and business operations. Lenders should view background checks as a complementary tool to assess risk and inform lending decisions rather than as the sole basis for judgment. Care should be taken to ensure results are evaluated in a way that does not result in any unintended bias in the lending decision.

Each lending institution may have its own risk tolerance and lending policies. Some lenders may be more willing to work with borrowers who have experienced setbacks, while others may adopt a more conservative approach and prefer to avoid borrowers with certain negative indicators.

Although background checks are undoubtedly a valuable resource for evaluating the creditworthiness of borrowers, lenders should exercise sound judgment when interpreting the results. By considering background checks in the broader context of a borrower’s credit profile, lenders can make well-informed decisions.

Legal Compliance

It is essential for lenders to understand the risks involved in conducting background checks and ensure compliance with relevant regulations. When developing your evaluation matrix with the considerations outlined previously, keep in mind the following:

GLBA privacy regulations and commercial purpose loans. Under the Gramm-Leach-Bliley Act, financial institutions are required to protect the privacy and security of customers’ nonpublic personal information. However, these privacy regulations do not apply to business- or commercial-purpose loans. Although GLBA safeguards personal information in the context of consumer transactions, it does not impose similar requirements for commercial loans. Lenders should be aware of this distinction when conducting background checks for commercial mortgage applications.

State privacy laws and credit/background checks. State privacy laws may vary regarding the restrictions placed on lenders when obtaining credit reports or conducting background checks for commercial mortgage applications. However, many state privacy laws do not restrict a lender’s ability to access these reports or perform background checks when evaluating applications for credit extensions. To ensure compliance, lenders should familiarize themselves with the specific state laws applicable to the jurisdictions in which they operate.

FCRA and permitted purposes. The Fair Credit Reporting Act (FCRA) governs the collection, use, and dissemination of consumer credit information. FCRA specifically allows lenders to obtain credit reports and background checks for a permitted purpose, which includes extensions of credit or purchases of closed loans. Lenders must ensure they comply with FCRA requirements (e.g., obtaining permissible purpose certifications from credit reporting agencies, using the information only for intended purposes, and providing adverse action notices when required).

Market practice and obtaining permission. Although certain regulations allow lenders to access credit reports and perform background checks for commercial mortgage applications, it is considered a market practice and good business ethics to obtain permission from the borrower or principal or guarantor. This permission should be documented and kept on record to demonstrate compliance with industry standards and to establish a transparent borrower-lender relationship. It also helps to mitigate any potential disputes or concerns regarding the invasion of privacy during the application process.

The practical result of this is the lender is now evaluating the individuals associated with the borrower entity. If certain discriminatory practices or patterns appear (based on protected classes such as age, gender, race, or religion), then it could potentially open the lender to aggressive plaintiff litigation. Although the law is on the lender’s side, it would still be a costly case to defend. It would also tarnish the lender’s reputation in the marketplace.

Conclusion

Running background checks and reviewing credit reports are important steps in evaluating commercial mortgage applications. Although GLBA privacy regulations do not apply to commercial-purpose loans and state privacy laws generally do not restrict lenders in this context, lenders must still adhere to Fair Credit Reporting Act (FCRA) requirements. This includes ensuring the permissible purpose for accessing credit reports and background checks and obtaining permission from the borrower or relevant parties. By understanding and addressing these risks, lenders can navigate the background check process effectively, make informed lending decisions, and maintain compliance with applicable laws and industry practices.