The 5 C’s of Credit: Your Path to Loan, Mortgage, and Credit Card Approval

There's nothing like the initial rush of excitement of owning your own business. Oh, the freedom!  There are seemingly endless possibilities when you're pre-approved for a loan that will allow you to finance a piece of new real estate, purchase a company truck, or equipment you need so your business can operate smoothly.

But there are some parameters you need to keep in mind to ensure you are given the chance to pursue those financial opportunities, and this is true for both consumers and businesses.

Let’s dig into each of the five Cs of credit so you can gain a competitive edge and effectively conquer your future.

 

1. Character - Can you make your payments on time?

Like in life, the character of a person weighs heavily on how others, or in this case, lenders, think of us. In the context of finances, your character refers to how reliable the vendor views you when it comes to making your payments on a loan or debt. Lenders will look at an individual's credit score when deciding to approve a loan, credit card, or mortgage. This is done through credit bureaus that take your credit history, compile a credit report, and send it to companies, such as FICO, that will assign a credit score to the report. The higher the score, the less of a lending risk you appear to be.

Personal financial information isn’t just for consumer-focused purchases, however. As a business owner applying for a loan, you will need to provide your personal financial information to illustrate you are in good financial standing. And if you’re going into business with a partner, their financials will influence the lender’s decision, as well. 

Wondering how to start accumulating a credit history? This most likely has already begun for you. Lenders will look at an individual's credit report, which compiles your previous payments made to loans and your credit card. If you do so on time and in full, your history should show promising results.

Worth noting, some things that may dissuade lenders from approving an application could include late payments, bankruptcy, or foreclosures. 

In order to minimize the risk on the lender's behalf, they may assign a minimum credit score in order to qualify for a loan. This is extremely important to watch for as it may affect your ability to qualify for credit. It is important to pay off your credit cards and loans on time and in full to ensure your credit score meets the required minimum score to qualify for a loan.

 

2. Capacity - Can you manage more debt?

Your debt-to-income ratio, or DTI, is determined by the amount of debt you have compared to your income. Lenders take your DTI into consideration to determine your likelihood of paying off your debt on time.

Your DTI ratio is the opposite of your credit score. In general, a low DTI shows lenders that you are in good financial standing to be approved for a loan and have the ability to pay back the debt incurred on it. An easy way to keep yourself in check is by following the guidelines from the Consumer Financial Protection Bureau, which recommend that you keep your DTI ratio at 36% or less if you’re a homeowner, and 15-20% if you are renting.

As a small business owner, your DTI ratio should be under 50% to be considered for a loan.

Tip: To calculate your DTI, add up your monthly debt payments, divide the number by your income before taxes, then multiply that number by 100.

Collateral is an asset that can vary depending on what type of credit you are looking to get. Collateral, such as a property or piece of equipment, is usually needed for approval on a secured loan or credit card. Think of collateral as a means of showing the lender that you are good on your word to pay back your debts.

Varying asset types can be used as collateral. For example, cash is usually used as a deposit to get approval from a lender for a credit card. For an auto loan, the vehicle itself is used as collateral.

For those who may not be able to make payments or that have previously been denied a loan, offering up collateral is a great way to hedge approval and give the lender peace of mind. But be mindful: If this credit is not paid back, then your collateral will be taken as a way to make up for it.

 

4. Capital - Showing your monetary worth

Capital is made up of your savings and assets that can be used as collateral toward your loans. An example of this is the down payment on a new home. The larger the down payment, the better the interest rates and loan terms will be because it shows the bank how serious you are about paying back the debt owed.

Capital will also illustrate to the lender that you will continue to pay off your loans, even if your income stability changes.

 

5. Condition - How outside factors affect your credit worthiness

Conditions include both the external factors in play when you ask for a loan, and what you will use the loan for. Lenders will often look into the state of the economy, industry trends, and federal interest rate trends. If the economy is heading toward a recession or in bad standing, lenders may increase the standards to qualify for a loan because it is riskier for them to lend out funds.

Looking at uses for loans, lenders are more likely to grant you your loan if there is a specific purpose and plan for the loan. You are more likely to receive one if you have a plan, like sharing your business plan for a business loan, rather than receiving a personal loan. This is because a lender is risk-averse; it is riskier for a lender to grant a loan when there is no plan in place to earn income and pay back your debt.

 

Conquer your Credit

Set yourself up for success when asking for a loan or applying for a credit card by following the five C’s: character, capacity, collateral, capital, and conditions. Each of the five Cs plays an important role in getting approved for a loan or credit card, which can help you take your business to a new level.

 

If you are looking for support with your business plan or securing a loan, ask a Rockland Trust business banking officer how they can help you!

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