Five Cs of Credit Lending

Banks don't lend money to just anyone who walks in off the street and asks for it. The days when a strawberry picker making $14,000 a year could get a $700,000-plus mortgage (true story, believe it or not) are history, and lenders are applying tried-and-true measures of borrower creditworthiness. One well-known set of criteria are the "Five C's of Credit" -- character, capacity, capital, collateral and conditions. Though most commonly cited in the context of business lending, the five C's apply to consumer borrowers, too.


Ask yourself whether you would lend your own money to someone you'd never met who had a long criminal record, bad credit, a recent bankruptcy or who reeked of booze when he asked for the dough. You'd probably say no. (Please say no.) So would a commercial lender. Banks look for borrowers with good character. That doesn't mean you have to go to church or clean up trash on your days off. It means that a background check will turn up no red flags that would call into question your willingness or ability to fulfill your financial obligations, and that you can supply references who will testify to your reliability and integrity.


Probably the most important of the five "C's," capacity is your ability to pay the money back. Banks like to see steady income, low existing debt payments and significant financial assets to fall back on in a pinch. You can be the greatest, most earnest, most upstanding citizen there is, but if you can't demonstrate the capacity to repay the loan, you'll get a firm "no" from the lending officer. She might smile when she says it, though.


Perhaps you've wondered why it's so important to banks for you to make a sizable down payment when you make a major purchase -- why, for example, your interest rate is so much better when you put down 20 percent on a house than when you put down only 5 percent. The answer: Lenders want you to have some skin in the game. If you have none of your own money invested in a house, a car, a small business, whatever, it's that much easier for you to walk away from your debt payments. Borrowers who won't commit their own capital are a higher risk.


Bad things can happen to even the best borrower. You could have sterling credit, a good job and money in the bank. But it can all disappear quickly, be it from a job loss, big medical bills or bad investments. So lenders want you to put up collateral -- hard assets that they can seize in the event you default. With a typical home loan or car loan, the collateral is the home or car itself. But an entrepreneur wanting to borrow money to start a business can't put the business up as collateral, because if the enterprise fails, there would be nothing to seize. That's why so many entrepreneurs have to borrow against their homes or other assets.


"Conditions" is the most elastic of the five C's. "Conditions" encompasses such things as the purpose of the loan; the specifics of the loan agreement, including the term, interest rate and payment schedule; and the overall lending environment, from the market for the type of loan you're seeking all the way up to the condition of the economy as a whole.

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