Once you have your loan application package in order and you are ready to go to your loan meeting, what exactly are the lenders evaluating? To measure the creditworthiness of a borrower, most lenders consider what is known as the "Five C's:" character, capacity, capital, collateral, and conditions.
Now, click through the tabs below to learn more about the "five C's" of a loan evaluation.
For lenders, a borrower's character is reflected through their credit history and credit score. A person with a good credit history and a high credit score is presumed to have good character and is more likely to be approved for a loan than a person with a bad credit history and a low credit score.
This is a borrower's ability to pay back loaned money. Lenders will look at your income and employment history to gauge your ability to repay any debts you have. They will also look at your debt-to-income ratio—the ratio of your current monthly debt to your gross income—to see how much of your monthly income is spent on debt.
For example, say you have monthly debt payments totaling $2,100 and your gross monthly income is $6,000. This means that your debt-to-income ratio is 35% because 2,100 is 35% of 6,000. Every lender is different, but usually anything near or above a debt-to-income ratio of 35% will not be looked at by lenders in a positive manner.
Capital is the total amount of money a borrower has, including their total income, investments, and their assets—such as a house or a car. This amount will show the lender that you have enough money to pay back the loan.
This is an asset that can be used to back the loan or used as security for the loan. Collateral—a car, a house, a boat, etc.—helps the borrower secure the loan by assuring the lender that they will get something in return (whatever item the borrower put up as collateral) if the borrower for some reason can no longer afford to pay back the loan. Putting up a personal asset for collateral when taking out a loan will usually result in a lower interest rate and better terms.
These are the details of the loan, including its purpose, the principal balance, and the interest rate(s). For example, a lender may not want to give you a loan for a car if you already have a car. Or maybe the lender offered you a loan with an extremely high interest rate and now you do not want the loan. Even if the other "C's" have been good, this one may make or break you getting the loan.
Level Up!
Now, use the information above on loan evaluation criteria to complete the following practice activity. For each scenario, determine which of the 5 "C's" is being evaluated. When you are ready, click each box to flip it and reveal the solution.
