The 5 C’s of Credit

Have you ever wondered what goes into getting a loan? What are the things a lender looks at when considering giving you one? There are five aspects, and they all affect the chances of a lender considering and approving you for a loan. The aspects that go into the decision are character, capacity, capital, collateral, and conditions. These are often referred to as the 5 C’s of Credit Information and they are all important for different reasons.

Character is the lender’s opinion of your credibility and trustworthiness. A lender won’t want to lend to someone they feel can’t keep a commitment, so it’s important to make sure you keep track of your current debts. Things that affect your character assessment are things such as: when you pay your bills, liens on accounts, and past bankruptcies.

Capacity is you ability to repay your loan. If you don’t make enough income to repay your debts, it’s likely you’ll be declined for a loan because the lender is worried about a default. A loan is still a debt that must be paid in full. Lenders will look at things such as credit score, borrowing, and repayment history when determining your ability to repay them.

Capital is the amount of money you have invested in the venture whether it be a new car, home, or something else. Lenders are more willing to loan you money when you place a stake in the financial obligation as well, because it shows you are serious about it and it allows them to not place a complete risk on their part.

Collateral is assets that can be used as security. It acts as a backup source in case you cannot repay your loan. It’s often considered to be a hard asset or working capital, such as accounts receivable. A car is considered collateral on a car loan and may be repossessed if the loan is not repaid.

Conditions are how the loan will be used and how that could be affected by economic or industrial factors. Lenders want to ensure a loan can be repaid and protect themselves from any risks they find. Things such as the competitive landscape and industry-specific issues can affect this.

This is just a basic overview of the 5 C’s. Below there is a more in-depth look at each aspect, why it matters, and how you can master them to ensure success!

What it is: A lender’s opinion of your general trustworthiness, credibility, and personality.

Why it matters: Banks want to lend to people who are responsible and keep commitments.

How it’s assessed: From credentials, references, reputation, and interaction with lenders.

How to master it: “Character is something you can control and promote, but only if you have a bank that cares about relationships,” Brad Farris, a business advisor with Anchor Advisors in Chicago says. If you have a local or community bank, work to build a relationship. Farris recommends sharing good news about your business with your banker to help build that relationship and asking if he/she wants to be added to your company’s newsletter. “Make yourself someone they want to lend to,” he says.

Sometimes called credit history, the first C refers to your reputation or track record for repaying debts. This information appears on your credit reports. Generated by the three major credit bureaus – Experian, TransUnion and Equifax – credit reports contain detailed information about how much you have borrowed in the past and whether you have repaid your loans on time. These reports also contain information on collection accounts, judgments, liens and bankruptcies, and they retain most information for seven years. The Fair Isaac Corporation (FICO) uses this information to create a credit score, a tool lenders use to get a quick snapshot of creditworthiness before looking at credit reports.

Capacity/Cash flow

What it is: Your ability to repay the loan.

Why it matters: You must generate enough cash flow to repay the loan. Loans are a form of debt, and they must be repaid in full.

How it’s assessed: From financial metrics and benchmarks (debt and liquidity ratios, cash flow statements), credit score, borrowing, and repayment history.

How to master it: Some online lenders may be more open to helping you finance immediate cash flow gaps. If you’re focusing on local banks, pay down previous debt before you apply. Also, calculate your cash flow to understand your starting point before heading to the bank.

Capacity measures a borrower’s ability to repay a loan by comparing income against recurring debts and assessing the borrower’s debt-to-income (DTI) ratio. In addition to examining income, lenders look at the length of time an applicant has been at his job and job stability.

What it is: The amount of money invested by the business owner or management team.

Why it matters: Banks are more willing to lend to those who have invested some of their own money into the venture. Most lenders are not willing to take on 100% of the financial risk, so it helps borrowers to have some “skin in the game.”

How it’s assessed: From the amount of money the borrower or management team has invested in the business.

How to master it: Nearly 60% of small-business owners use personal savings to start their business, according to the Small Business Administration. So put some of your own resources into the mix. There are other ways, however, to acquire start-up funding if you don’t want to take on all the risk yourself

Lenders also consider any capital you put toward a potential investment. A large contribution by you decreases the chance of default. For example, when you have a down payment for a home, it’s typically easier to get a mortgage. Even special mortgages designed to make homeownership accessible to more people, such as loans guaranteed by the Federal Housing Authority (FHA) and the Veterans Administration (VA), require borrowers to put between 2 and 3.5% down on their homes. Down payments indicate the borrower’s level of seriousness, which can make lenders more comfortable in extending credit.

What it is: Assets that can be pledged as security.

Why it matters: Collateral acts as a backup source if the borrower cannot repay a loan.

How it’s assessed: From hard assets, such as real estate and equipment; working capital, such as accounts receivable and inventory; and a borrower’s home that also can be counted as collateral.

How to master it: Picking the right business structure can help protect your personal assets from being used as collateral if you’re sued or if a lender is trying to collect. Making your company a legal entity will help you mitigate the risk.

Collateral can help you secure loans. It gives the lender the assurance that if you default on the loan, the lender can repossess the collateral. For example, car loans are secured by cars and mortgages are secured by homes.


What it is: How the business will use the loan and how that could be affected by economic or industry factors.

Why it matters: To ensure that loans are repaid, banks want to lend to businesses operating under favorable conditions. They want to identify risks and protect themselves accordingly.

How it’s assessed: From a review of the competitive landscape, supplier and customer relationships, and macroeconomic and industry-specific issues to ensure that risks are identified and mitigated.

How to master it: You can’t control the economy, but you can plan. Although it might seem counterintuitive, apply for a line of credit when your business is strong. “Banks will always be happy to loan you money when you don’t need it,” Farris says. If conditions worsen, they may reduce the credit line or take it away, he adds, but at least you have some cushion for a while if things go south.

The conditions of the loan, such as its interest rate and amount of principal, influence the lender’s desire to finance the borrower. Conditions refer to how a borrower intends to use the money. For example, if a borrower applies for a car loan or a home improvement loan, a lender may be more likely to approve those loans because of their specific purpose, rather than a signature loan that could be used for anything.

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