Need to apply for a loan? Lenders will determine your creditworthiness through a review process known as the five c’s of credit—character, capacity, capital, collateral, and conditions.
Financial institutions need to know you can pay back the money you’ve borrowed. Through the five c’s of credit, traditional lenders look at how you’ve managed debt in the past and if you’re able to take on any more. Understanding these financing standards is key toward helping you qualify for the credit you require.
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as quick and easy as possible. Here are the five characteristics you need to increase your likelihood of getting that loan. 1. Character
Character refers to your reputation as a borrower. Your personal credit history—or how you’ve managed money in the past—can make or break you when getting a loan. This information appears on your credit report, generated by the three credit bureaus: Experian, TransUnion, and Equifax.
Based on your credit history and report, FICO and Vantage use this information to determine your credit score. They will look at vital details like your payment history or if you have any negative marks like late payments, bankruptcies, or foreclosures.
Keep in mind that each lender abides by different criteria for evaluating your credit history. They may also require a minimum credit score. Typically, the higher the credit score, the less a credit risk you are in the eyes of the lender.
MORE: What is a good credit score for a car loan?
2. Capacity
Capacity assesses your ability to repay loans. Lenders decide your capacity by looking at your debt-to-income (DTI) ratio—or how much debt you have versus how much income you earn. They calculate your DTI by adding your total monthly debt payments and dividing that by your gross monthly income.
A low DTI ratio indicates to the lender that you are not high risk and may have the capacity to take on additional monthly loan payments. The Consumer Financial Protection Bureau
(CFPB) recommends having a DTI of 43% or lower, as most borrowers at this percentage can comfortably afford their monthly payments. 3. Capital
Capital refers to any funds—such as savings or investments—that you put towards a potential financial investment. Down payment size matters! Generally speaking, the larger the down payment, the better your chances are of getting the best interest rates and loan terms.
Lenders usually look at household income as your primary source for paying off your loans. If you or someone in your household loses a job, the capital you put forward offers added security for the lender.
4. Collateral
Collateral can help you secure a loan when your creditworthiness is not up to par. Lenders see collateral as a secondary source of repayment for the loan.
If you apply for an auto loan, for example, you can use the car you are purchasing as collateral. So if you default on your payments, lenders can recover what they are owed through the agreed collateral.
Collateral-backed loans are often referred to as secure loans. These types of loans are typically considered less risky for lenders to issue. If you don’t have the best credit, a collateral-backed loan may be a great opportunity to build your credit.
5. Conditions
Besides your income, conditions include additional information that lenders require to establish if you qualify for credit. This may include:
The length of time you’ve been employed at your current job
How you intend to use the money
Lenders will also look at external factors that are not in your control, such as the current economy, federal interest rates, and industry trends. It might not be fair to you, but lenders must assess their own risk when issuing loans during uncertain times.
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Why are the 5 c’s so significant?
The five c’s of credit allow lenders to decide if you’re eligible for a loan by evaluating your creditworthiness and the likelihood that the loan (principal and interest) will be repaid in full. Through this financial assessment, lenders determine how much you can borrow and what your interest rate will be.
Not sure if your creditworthiness matches up? Here are a few tips on how to improve your chances of securing a loan:
Character: First things first, always make payments on time! How much credit you are using—as known as your credit utilization—should always be low. Don’t make any purchase you cannot pay back right away.
Capacity: A low DTI demonstrates that you can handle a new loan payment. For this reason, you should only apply for the credit you need.
Capital: Lenders feel more assured when you have funds in hand, such as savings or other lucrative investments. If you need a hefty loan, start saving for a down payment.
Collateral: If your creditworthiness is deemed risky, you may have to put something up for collateral to take out a loan. Make sure you take out a sensible loan to ensure you can handle monthly payments. As long as you closely follow the loan terms and make your payments on time, you will be able to keep your collateral.
Conditions: Though economic conditions may be out of your control, they can still impact your credit application. It’s always wise to be aware of what’s going on in the current economy to determine if you will qualify for credit in the near future.
The five c’s of credit provide lenders with a financial framework to objectively establish if you’re eligible for a loan through a history of responsible credit use. It is helpful to keep these five characteristics in mind as you work toward your future financial goals.
Key Takeaway Through the five c’s of credit, lenders decide if you qualify for credit. Be aware of your credit history and use the five c’s of credit as a guide to put yourself in a better position to qualify for a loan.
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