Many customers get frustrated as to why they’re having trouble securing a loan from various lenders. One of the most important factors that affects these lending decisions are the 5 Cs of credit. We’ve gathered info from some great resources to help you better understand why these 5Cs could be key to your next successful financing application.
What are the 5 Cs of Credit?
Lenders will make their decisions on a potential borrower’s credit worthiness using the 5 Cs system. The 5 Cs include: Character, Capacity, Capital, Condition, and Collateral – all of which are factored together to determine the lender’s risk of financial loss and whether the applicant will be successful in repaying the loan.
Character
Character is the applicant’s credit history. Lenders will look at your past behavior to determine your future success. In other words, your “character” is built by a history of repaying loans and being reliable in making payments. Lenders will review an applicant’s credit history or credit score – a value agencies will give you to reflect your credit history. Ritchie Bros. Financial Services will find lenders that work with all types of applicants, regardless of credit score and credit history.
Capacity
Capacity indicates a borrower’s ability to repay their loan based on their available cash flow. This is known as the applicant’s debt-to-income ratio. Lenders want to be sure you have the ability to successfully make repayments based on the terms of the loan. They don’t want you to be overstretched financially because that increases the risk of default for the lender.
For business-loan applications, lenders like financial institutions will examine the company books, including past cash flow statements, to determine how much income can be counted on from operations. For individual borrows, statement of income and stability of employment will be major factors in determining future capacity for loan repayments.
Another important factor is the borrower’s current debt obligations compared to the amount of revenue expected in the future. A high debt to income ratio will be viewed as a high risk by lenders and may affect the terms of repayment.
Capital
The amount of money an applicant has. The borrower’s capital level could include personal investment into the firm, retained earnings, and other assets that business owner controls. A high level of capital is viewed positively by financial institutions because it tells lenders that the applicant is strongly incentivized to ensure the company’s success. Banks, for example, will measure capital quantitatively as a percentage of the total investment cost. Providing proof of home ownership document such as property tax assessment or a mortgage statement is a good way to show your capital level.
Collateral
An asset that can back or act as security for the loan. Lenders want to know if you have something of value you can put up as security for a loan. For businesses, this could be accounts receivable or equipment, while individual applicants might use savings accounts, or assets like trucks and real estate. By having collateral your loan will be considered “secured” and looked on more favorably by lenders because they can collect something in the unfortunate case of default.
Conditions
The purpose of the loan, the amount involved, and prevailing interest rates are considered conditions. These might not be entirely in your control. Lenders will review the overall economy – its strengths and weaknesses – and current interest rates set by banks and financial governing bodies. Another big condition is the purpose of the loan or assets – how you plan to use the funding, do the assets make sense to the nature of the business? From a bank/lender’s perspective, it’s always a good idea for the customer to explain the use of the assets for their business.
Financing for working capital, equipment, or expansion are common reasons for business applications. Individual borrowers are scrutinized also for their need to take on more debt, such as financing major equipment purchases. Conditions are the most subjective factor on the 5 Cs.
Navigating your next move in unpredictable times
Each lender measures the 5 Cs in their own way as there is no one standard in the industry. Here at Ritchie Bros. Financial Services , we can help simplify the process by partnering with multiple lenders from the U.S. and Canada. We work with lenders across the spectrum to find credit providers that are ready to help tailor financing to your specific needs.
If you are looking for a team of financing specialists that will understand your business needs, and provide you with an ample and flexible offer, we are your one-stop-shop.
Contact us today to navigate your next move.