Have you ever wondered what lenders look for when deciding whether or not to lend you money? They look at five key factors — character, capital, capacity, conditions and collateral — to determine your credit worthiness. Know the five C’s of credit before you apply for your next loan. It could mean the difference between ‘yes’ and ‘no.’
Capacity is what lenders see as your ability to repay the loan. A lender must determine whether or not you can afford to repay your loan. To do so, they will likely consider factors such as your past and present debt payments as indicators of future payment ability in relation to how much money you bring home. The lender wants to make sure you have enough extra income to be financially secure after all of your bills are paid.
Capital refers to your net worth — the value of your assets (e.g. car, real estate, cash, and investments) minus your liabilities (e.g. debt). A lender needs to gain a clear picture of your personal financial situation. A higher net worth suggests you are able to remain financially secure in case of a negative life event.
It is important for the lender to have a general idea of your character. Factors such as your credit rating and borrowing history are weighed against more subjective considerations such as honesty and integrity. Lenders review all of the factors to form an assessment of your ability and willingness to repay your debt.
Collateral refers to any asset (e.g. a home or cash) you promise as security against a line of credit. The lender will use this asset to cover the debt if you default on the loan. In some cases, lenders require a second signature in addition to collateral. This means the co-signer agrees to pay the loan if you can’t. This gives the lender an extra level of security that the loan will be repaid.
The lender will consider how outside market forces such as the state of the local economy will influence the conditions under which they lend you money. The lender may evaluate the financial health of your employer to try to gauge whether or not you will lose your job and become unable to repay the loan. If approving your request, lenders will likely establish certain conditions by which they will lend you money such as the loan’s purpose, the terms of the loan, interest rate and payment schedule, for example.
Lenders weigh all the five factors above carefully to create a more holistic picture of you and your financial habits before deciding to give you a loan.
Article provided by Local Government Federal Credit Union.
The advice provided is for information purposes only. Consult your financial advisor for additional guidance.