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The 5 C's of Credit

Sep 18, 2020, 10:37 AM
Loan approval screen with happy couple standing in front of home

Are you looking at getting a loan or a credit card? When applying for a loan, lenders assess a number of different factors, with most (if not all) falling under the 5 C’s. If you’ve ever wondered what lenders look at when you submit a credit application, you’re in the right place! Here’s what lenders look for in a credit application (also known as the “5 Cs”):

The first C is Capacity.

Capacity looks at your ability to repay debt. When looking at capacity, lenders look at employment history, stability, income, and debt to income ratio. Capacity is one of the most important C’s, as lenders want to know that you can pay them back. If you don’t have the ability to pay them back, it is too risky for them to lend you money. Debt to Income is also very important when looking at capacity. You must have more income than you do debt, to cover not only your loans and credit cards, but daily expenses.

The second C is Capital.

Capital considers the amount of money (whether physical or assets) that you are contributing towards the loan. Often, capital is how you make both your monthly payment, and your down payment. Most lenders consider your household income your main source of capital, but depending on the loan type, the type of capital may look different. The more money that you are willing to give up front, the more lenders will trust you, as they have some insurance if you don’t pay your loan back.  In a nutshell, lower loan amounts mean lower risk for the lender.

The third C is Character.

Character takes into consideration your credit history and credit score. The better your credit history and credit score, the more lenders see you as someone who is trustworthy and more likely to pay back the money they’re considering loaning you. The presence of any delinquent accounts, foreclosures, and tax liens are just some of the things lenders look for when evaluating your application. The more derogatory notes you have on your credit report, the less likely they are to approve your request. And when it comes to character, it’s possible they may even ask for references. 

The fourth C is Collateral.

Collateral considers the assets that you can secure a loan with. With a secured loan (such as an auto loan), the lender has insurance if you don’t make your payment. Collateral looks different depending on the specific loan type that you are applying for. With any loan, the lender will look at the value of your collateral in comparison to the value of the loan. This is called the Loan-to-Value ratio or LTV.

The final C is Conditions.

“Conditions” refers to the current environment and what you are using the loan for. Lenders look at how the current economic climate will affect your loan. For instance, is now a good time for lenders to loan money on an investment property? They also consider what you are using the loan for, to get a better idea of how the money will be allocated, in turn helping them in their lending decision.

Understanding what lenders look at while demonstrating good credit behaviors, will help you prepare for your next borrowing need – whether it’s an auto loan, mortgage or personal loan.

If you find yourself needing some help improving these areas, we’re here for you! Learn more about borrowing money and increase your financial literacy with our Financial Wellness Coach program. To learn more about loans, or fill out a loan application, visit useagle.org/borrow today. 

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