The Five Cs of Credit

12 Nov 2020

How Knowing the Five Cs Of Credit Can Help You Score a Loan

Whether you’re seeking bridge financing, a rehab loan, a private commercial real estate loan or simply a traditional mortgage, knowing if you can satisfy the requirements of each of the Five Cs of Credit will increase your chances of getting a deal across the line.

Essentially, the Five Cs Of Credit is a system used by lenders to determine the creditworthiness of a prospective borrower. Both banks and alternative lenders, such as hard money lenders and private money lenders, use this system. It involves both qualitative and quantitative measures and looks at a range of things including your credit reports, credit scores, income statements and other relevant documents as well as details about the actual loan.

Knowing the system will help you work out what lenders are looking for when you apply for a loan. If you’re aware of what the Five Cs are and where you stand in relation to each of them, you’ll be much better placed when it comes to being approved for the loan.

So, what are the Five Cs Of Credit?

The Five Cs Of Credit include:

• Character
• Capacity
• Capital
• Collateral
• Conditions

And here’s what you need to know:

Character

The most comprehensive of the Five Cs, character refers to your track record for repaying debt. In other words: your credit history. A lender will make this determination by looking at your credit reports which reveal information dating back seven to ten years regarding your previous debts, whether you’ve repaid these debts on time and if you’ve been bankrupt. This information is used to determine your credit risk and evaluate your credit score. Credit scores – often known as FICO scores – range from 300 to 850. Many lenders have a minimum credit score requirement for you to be eligible for a loan. However, don’t despair if you don’t have an exemplary score. Many short term bridge loans lenders offer low credit loans, accepting applicants with average credit scores or even low credit scores.

Character also takes into account your general trustworthiness and personality. Lenders make this assessment based on your work experience, credentials, references and previous interactions with lenders. Having a good, steady job or someone reputable who can vouch for you, for example, can help you improve your character in the eyes of a lender.

Capacity

A very necessary factor for determining risk to a lender, capacity refers to your ability to repay a loan. This is determined by comparing your income against your debt and assessing your debt-to-income (DTI) ratio. The lower your DTI ratio, the better chance you have at qualifying for a new loan. If your DTI is affecting your ability to get a loan, consider paying down any existing debts to help reduce your DTI and improve your capacity.

When assessing capacity, lenders also take into account the length of time you’ve been employed at your current job as well as your job stability. If you’ve recently switched jobs, you might need to wait longer before applying for a new loan, or, if you’re planning on switching you might want to put that plan on hold while you attempt to secure finance.

Capital

Another factor banks or hard money lenders consider is the additional sources of capital you have to repay the loan in the event you become unemployed or experience any unexpected hardships. These additional sources include things like your savings as well as other investments and assets.

Capital also refers to having much money you have to put towards your potential investment. The more cash you have to contribute, the lower your risk of default and therefore greater the likelihood of being approved. Larger contributions might also mean better rates and terms.

When it comes to using hard money or private money to finance an investment such as a fix and flip purchase or a commercial rehab investment, alternative lenders can often lend the full amount, though some prefer to only cover 80%, which means you’ll need a 20% down payment ready.

If you’re having trouble meeting the Five Cs, saving up some extra capital can certainly help you secure a loan.

Collateral

Collateral refers to assets that you can use to back or act as security for a loan. Essentially, collateral gives assurance to the lender that they’ll be able to recover something if you default on your loan, making you a less risky option. These assets include other properties or other financial assets such as bonds. The bank or private money lender will evaluate the value of this collateral and minus any existing debt from this value to determine your available equity.

If you don’t have collateral to offer and you’re finding it difficult to get approval for a loan, consider whether you have someone you can ask to act as guarantor.

Conditions

This is where external factors come in. For instance, lenders will look at certain conditions that are beyond your control such as the current state of the economy, prevailing interest rates and any pending legislative changes that might have an impact on your investment. Lenders also consider conditions such as how much money you want to borrow and for what purpose. A loan with a specific purpose – such as a renovation loan or an equity bridge loan, for example, are often more likely to be approved than a loan without a clear purpose such as a good faith loan or a signature loan. 

It’s important to note that there are no strict guidelines in place when it comes to the Five Cs Of Credit which means different lenders place different weight on each of the five Cs. Commercial hard money lenders may be more interested in collateral or conditions rather than your credit history. In any case, understanding the Five Cs of Credit is the key to securing finance. If you’re ready to apply for a loan, get in touch with Alpha Funding today.