Credit Reports are Removing Tax Liens: What Lenders Need to Know Published July 21, 2017
According to the Consumer Data Industry Association, beginning July 1, 2017, Equifax, Transunion, and Experian all began deleting approximately 50-60 percent of tax lien data and 96 percent of civil judgments from their credit reports. Before you start contemplating whether the credit bureaus have gone off the altruistic deep-end, know that these changes were largely driven by their improper verification processes and slow updating of records that resulted in many disputes and complaints.
As a result of these changes, there’s understandably a lot of uncertainty around how borrowers and lenders will be impacted as these credit risk indicators are being wiped away from up to 20 million American’s credit reports.
With a small dose of understanding how credit bureaus work and knowledge of what steps to take to ensure you’re utilizing some tax due diligence best practices, you can remain informed and protected with a full view into your prospective and current borrowers’ tax history.
How are Public Records and the Credit Bureaus Related?
Let’s start with a clear distinction–credit bureaus are not where public records are actually filed and recorded. The bureaus merely scour the places where public records are recorded, ie. county courthouses, Secretary of State offices, federal court records, state records, etc. to aggregate the data and generate a proprietary credit score. For lenders issuing credit, this score should represent a level of creditworthiness to determine credit terms and ultimately, mitigate losses due to bad debt.
Simply put–public record searches and credit reports are not to be viewed as interchangeable tools for underwriting.
How Will These Updates Impact Borrowers?
While it’s too early to tell how this shift will change credit scores and the credit quality of consumer loans, consumers have a reason to rejoice, for now. They’ll presumably have better credit scores and broader access to credit with improved terms.
However, as long as lenders accept that individuals with tax debt present a higher credit risk, this new world order doesn’t make the borrowers any less risky. The visibility into this risk is merely shifted to lenders and their underwriting teams looking to assess the creditworthiness of their borrowers.
What Do Lenders Need to Know About Their Risks?
This shift of risk from borrowers to lenders isn’t a new phenomenon. In fact, when it comes to federal tax liens, the IRS has been shifting the risk to lenders for years by filing less tax liens than ever (57% reduction from 2010 to 2016) meanwhile, increasingly more businesses are falling behind on their tax obligations–read one our blogs on this topic.
Regardless of the reduced visibility of tax liens on credit reports, the IRS will still be filing and publicly recording them as they see fit. It’s just that they won’t impact the credit scores the way they did previously.
Because most commercial lenders aren’t using a standalone consumer credit score to underwrite a small business loan, it’s pretty safe to say the major impacts won’t be felt by them as long as they adhere to underwriting best practices as they pertain to federal taxes.
Tax Due Diligence Best Practices for Lenders
As lenders who are focused on mitigating risk, increasing profitability, and preventing defaults there’s little time and room for miscalculations. Below are some practice pointers to keep in mind when undergoing due diligence on your borrowers:
Best Practice Tips
- In general, when looking to obtain data to make a credit decision, go as close to the source of the data as possible.
- Understand that by the time-
- a public record is filed (ie, tax lien is filed at county recorder’s or Secretary of State’s office),
- then searched for and picked up by a 3rd party (ie., public records search vendor),
- then provided to your credit department with imperfect assumption that all your search criteria is perfect (ie. correct exact name variation, exact counties doing business, etc.)
- There’s a large margin for error and likelihood of outdated data.
- The updates to credit reports this month are proving them to be even more unreliable than ever.
- Note that public record search providers are only picking up tax liens when they are filed, not all tax debt information that you are looking for to make a credit decision.
- Conclusion – For federal taxes, the only way to know if a borrower is paying their taxes or not is to obtain complete historical tax compliance data (tax debts, missing tax returns, tax deposits, etc.) directly from the source, the IRS.
However, doing so is not without its complexities, as navigating the bureaucratic behemoth of the IRS and its disjointed organization has never been considered an effortless task. At Tax Guard, we’ve perfected this process to make it easy for lenders to quickly get the federal tax insight necessary to make a confident funding decision.
If you have any questions about how to make sure you’re getting all your borrowers’ federal tax information, please feel free to contact us to optimize your current processes.
