Credit Cycle

Credit Cycle

Today’s topic is a term that is very important to predicting market trends for investors and those looking for capital to start up a new business. A Credit Cycle is one of the primary factors that affects the ease of access to funding for both business and consumer borrowers and lenders. Let’s take a look at the specific definition of a credit cycle and how it affects individuals and businesses considering their credit options.

Definition: Credit Cycle

  • A cycle involving the level of access borrowers have to credit.
  • Cycle in which funds are easy to borrow at the beginning of the cycle due to the following:
    • lower interest rates
    • reduced or eased lending requirements
    • an increase in the amount of available credit

The Breakdown

What determines the start of a credit cycle? It’s quite simple: determination of risk. In periods of lower financial risk to lenders, such as when businesses and real estate are steadily increasing in value, they are more willing to be generous about terms of loans and lines of credit. As they stand less of a chance of taking a loss on monies loaned out, they typically ease borrower requirements. By the same token, when business is good, and real estate values are high, borrowers tend to be more willing to take out loans since interest rates are generally lower during times of economic prosperity as businesses and properties continue to appreciate in value.

The cycle typically peaks when assets and investments (businesses and property) start to lose value again due to natural market forces, or when they start to return lower percentages to their owners. This cycle makes it more difficult for borrowers to repay loans, and thus lenders begin to be more restrictive in their lending practices and raise interest rates to earn as much as possible from borrowers due to the higher risk of default. The credit cycle reaches its lowers point when restrictions and interest rates for borrowers are at their highest, and values for businesses and property at their lowest. This completes the cycle once more until values begin to increase again.

Ultimately, knowing where the cycle currently stands in the lending market is crucial to a successful startup or expansion using borrowed funds. A careful evaluation by financial specialists before borrowing is always a wise decision before taking out a line of credit or extending one. In finance and business, there is no such thing as a sure thing, but reading the market and making an informed decision should be integral to your organization’s process

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