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The 5 C’s of Credit

When applying for a loan, banks or lenders will assess your credit risked based on 5 factors. The 5 C’s of credit, as they are commonly known in banking, is a method lenders use to determine credit eligibility of potential borrowers. 5 different aspects of the borrower’s financial situation are weighed in an attempt to determine the possibility of default. These 5 characteristics include:

  • Capacity

  • Capital

  • Collateral

  • Conditions

  • Character

Here’s what you need to know to better understand what lenders are looking at when you apply for a credit line or loan.

Capacity

This factor represents the borrower’s ability to repay the loan. Lenders will look into your current and past income, employment history and stability. These are all good indicators of your ability to comfortably repay any outstanding debt. Your debt to income ratio may also be considered during the decision process.

Capital

Although lenders will look into your income as your primary source of repayment, they will also into potential capital. This includes any savings, investments and any other assets that can help repay the loan if the primary source of repayment fails. Having capital can be helpful if you lose your job or experience other setbacks, like a medical emergency.

Collateral

Collateral are additional sources of security you can offer the lender. Providing collateral means you can pledge an asset you own, like your home or car, to the lender with the agreement that it will function as the repayment source if you are unable to repay the debt. The value of your collateral and any debt secured by that collateral will play into the lending decision.

Conditions

From family emergencies to purchasing a vehicle, conditions represent how you plan to use the money. Lenders want to mitigate risks accordingly. Some other factors, like current environmental and economic factors, may also be considered by the lenders.

Character

While the other factors are easily measurable, character speaks to the general impression you make on a lender or bank. Usually, the lender will form a subjective opinion of you as to whether you are trustworthy to repay the loan or not. Your educational background, professional experience, quality of references and other elements will be considered in the decision process.

Now that you better understand the 5 C’s of Credit, you can better prepare for the questions you may be asked in the future when applying for a line of credit or loan.

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