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The 5 C’s of Credit When Applying for a Loan

Slide11A common evaluation framework is using characteristics of the borrower so they can gauge the chance of default. The Five C’s of Credit used are capacity, capital, collateral, conditions and character.

Capacity (ability to pay) it refers to your ability to succeed in making the loan payments. The lenders want to know exactly how you will be able to repay the loan. The lender will consider your earnings (wages if employed, revenues if self employed, etc.), and the probability of your successful repayment of the loan. Lenders will also consider payment history as an indicator of future payment potential. In the past whether you have paid on time or not, your history will show this and the lenders may be more reluctant to borrow you money if in the past you have not paid on time.

Capital – Lenders will generally consider your debt-to-equity ratio to understand how much money the lender is being asked to lend (debt) in relation to how much you have invested (equity). A high debt-to-equity ratio indicates that you already have a high level of loans and could be a higher financial risk.

Collateral (protection for the lender in case you do not pay) it is a form of security for the lender. Lenders require collateral for insurance in case you cannot repay the loan. If you default on the loan, then the lender takes possession of the collateral in place of the debt. (foreclose and take the property to cover the debt)

Conditions – Why are you needing the loan? house purchase, renovations, upgrades. How much do you want in relation to the total value? What is the economy doing? Are we in an increasing value or a decreasing one such as a turn down unstable economy which could cause a loss of jobs for instance. The more the positives there are,  the more likely the ease of obtaining the loan.

Character – By looking at your records such as payment history, your credit bureau report, possibly your employment record such as the length of employment will give the lender an opinion  of your trustworthiness in repaying the loan.

ps. Get your credit history in order, this is critical. Also Lenders / Banks share information so what they find out stays on your record and they share.

About Henri Simoneau

Henri Simoneau

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