You probably wouldn’t feel great if you score a “C” on an academic scale. However, if you are considering getting an auto loan or applying for a mortgage, then nailing the 5 C’s of credit is the key as they are used by the lender to evaluate the overall creditworthiness of potential borrowers.
The five C’s, or the characteristics of credit are; character, capacity, capital, conditions, and collateral. Understanding what they are is crucial as they will increase your chances of being qualified for a loan.
In this article, we’ll discuss all that you need to know about these five Cs of credit, including how lenders evaluate each of them so you can secure a loan. Read on!
What 5 C’s of Credit Are
Most financial institutions have adopted the 5 C’s of credit to understand – from the perspective of the lender – your financial situation and the possibilities of a borrower in repaying his debt.
What is character?
The lenders use character sometimes called “credit history,” to determine the reputation and trustworthiness of the borrower. This is done when the lender examines your credit report, bankruptcies, and how you’ve handled your past debts.
Why it is important: Lenders want to lend to responsible people who can keep commitments.
How To Improve:
You can impress your lenders with your character and increase your chances of being approved a loan with the following fours tips:
- Raise your credit score before applying for loans as a poor credit score can disqualify you from being given a loan.
- Your loan application will be favorably looked upon if you understand your credit report and if you clearly explain to the lender anything negative on your report. Ensure to correct any error that may negatively impact your credit report.
- Always be professional and polite when interacting with the lender whether in person or online lender. Your conversation with the lender should reveal that you are familiar with the loan application process.
- It is important to establish a good relationship with your banker. If the banker is already familiar with you, they may be more willing to grant your loan request quickly.
In simple terms, it is your ability to pay your debt obligations. Banks and lenders will determine the level of your cash flow by looking at your income, employment history as well as outstanding debts to see if the potential borrower has enough cash to refund the loan.
Why it is important: Lenders want to see that a borrower has a history of paying his debt on time and that he actually has the funds to do so.
How To Improve:
You can maximize your business’s capacity by following these three steps and demonstrate that your business can handle a loan:
- Try to completely pay off old significant amounts of outstanding debt. It is an indication that you have a history of paying off debts successfully. While this will show a potential lender that you can afford to repay a new loan, it will also increase the amount of cash flow available for a new loan.
- Lenders may want to use your Debt Service Coverage Ratio (DSCR). Your loan application will likely be approved if you improve your DSCR. The higher it is, the more cash you have to invest in your business. You can improve your DSCR by:
- Increasing your net operating income
- Decreasing your net operating expenses
- Canceling existing debt
- Just like the DSCR, lenders also place emphasis on debt to income ratio (DTI), in determining your capacity. This is the ratio between your gross (before tax) monthly income and your existing debts. The lower your DTI, the better your chances to take on more debt. Here are the two ways to reduce DTI:
- Increase your monthly income
- Pay off current debt
This refers to the amount of money invested by the business owner or business partners. It also includes assets that can be used to help repay the loan.
Why it is important: Lender feel more comfortable in granting a loan request if they know that you have sufficient capital investments or assets to part with if any financial setbacks occur during the life of the loan.
How To Improve:
Do the following if you want to present strong capital to a lender:
- First thing first, ensure that you actually have invested enough money in your business before applying for the loan.
- Secondly, highlighting the success of your past investments and then state clearly how you plan on using the loan they may potentially grant you.
- If you do not have any capital invested in your business, you’ll need to rely heavily on the other 4 C’s of credit.
Conditions are considered in two parts: the conditions levied on the loan and how economic factors can affect it. Lenders can access this from reviewing the economy, Interest rate, the competitive landscape, as well as supplier and customer relationships.
Why it is important: To avoid defaulting, lenders want to lend to businesses that operate in favorable conditions. They want to be able to identify risks and protect themselves accordingly.
How To Improve:
Apply these few tips on how to put your best foot forward where conditions apply.
- Let your lender know your well thought out plan instead of just stating the exact amount of money you need. They would want to know how you are planning on using the loan to benefit your business.
- Do not wait until the economy is poor and your cash flow is stagnant before applying for a line of credit. Apply, not just because you need money but because the economy is good and your business is booming.
- Even though the economy is poor or your business is slow, demonstrate your expertise to the lender on how your loan request will allow you to launch a profitable and promising business.
Put simply, collateral is an asset (or assets) that can be pledged as security. These can be accessed from real estate, jewelry, vehicles, equipment and savings accounts.
Why it is important: Collateral secures a loan in case the borrower is unable to repay it. They can be seized and sold.
How To Improve:
There’s no one right way to improve your collateral. But here is what you can consider:
- Evaluate your assets and their value carefully so that you know exactly what you can offer up as collateral.
- Find the lender that you are comfortable with as required collateral varies from lender to lender. But if you don’t have much collateral to offer up, continue to search until you find a lender that suits you.
You can get assistance here when searching for the perfect lender.