Understanding the Five Cs of Credit

 No matter what finance you are going for, lenders will always want to ascertain a basic five fundamental elements. The finance industry refers to these as ‘the five Cs of credit’ and can be critical to the success or failure of an application. These basic elements are aimed at painting the narrative of who you are and your history, what you want to do, and how you are going to be able to meet your obligations. This assists lenders to assess a general risk rating and minimise their chances of loss, and to ensure the most appropriate finance is applied to you – or if no finance should be provided at all.

Capacity 

A lender will want to know your capacity to repay the loan. They will also typically stress test an application to ensure you aren’t stretched, and that you have more capacity than the bare minimum to service any new and existing debt, on top of your income and other expenses. The ways to maximise your capacity can be to lower current debt levels, borrow less, reduce expenses, or increase your income. 

Capital

This is how much funds that can be provided to assist with a purchase. Typically, this would be your deposit on a purchase with some lenders needing minimum deposit amounts or want to see a certain amount of savings held for a certain amount of time i.e. Genuine Savings. For larger purchases, a plan may be needed to maximise your capital, and this starts with knowing just how much you will need.

Collateral

This is typically the security that is offered and gives the lender safety knowing finance can be re-paid in the event of a default. This doesn’t mean the loan has to be specifically secured against an item, for instance on an unsecured loan, lenders still want to know your assets and liabilities to understand the level of risk and likelihood of repayment in a default scenario. Generally, though, collateral is the actual security being purchased, and will work with your Capital (mentioned above) to work out the loan to value ratio. That is how much they are lending against the purchase price. A lower LVR can typically attract a lower interest rate, so having a higher deposit (Capital) or financing a cheaper item can assist in lowering repayments or loan terms.

Character

This is about who you are, what you do for a career, the stability of your employment and residence, and just a general picture of your situation. This will assist lenders knowing your appropriateness for finance and the specific product you are applying for. For instance, if you are going for a business loan, the lender may wish to see experience in the industry. For a personal loan, excessive gambling may be seen as an issue, even if all other parts of the loan service well. This also reflects on your credit file, so keeping this clear of defaults, and late payments, can help immensely in obtaining finance at the best rates.

Conditions

Conditions looks at the overall market conditions for the finance you are seeking. For home loans, an independent valuer will assess the property, and consider external factors such as market conditions, to assist in valuing the property. For business, an assessor may look to see the demand, risk to industry, and any specific encumbrances from operating in the industry, to assess the loan. As the conditions can be out of the control of the borrower, the way to mitigate this is to already have assessed any risks you can perceive and have some sort of strategy. For home loans, this could mean ensuring you have a larger deposit in case a valuation comes back short, and for business this could mean you have a business plan that includes contingencies if the market for your product or service deteriorates. 

By ensuring you have at least a general understanding of the above, this can not only help you obtain finance, but maximise your chances of favourable rates and terms. Contacting a loan broker can also help immensely, as they can help assess you the way a lender would, without needing to go through the formal loan application process. Additionally, if there are blemishes on your records, or issues for the finance you are seeking, a broker can assist with noting down mitigating circumstances, or aligning you with a lender who has policies around such problems. As such, a broker’s recommendations can prove to be invaluable before you put in a formal application for finance, and should be sought out when applying for finance.