The five Cs of credit are your best way to secure a loan or funding from various lending institutions such as banks, private lenders etc. The five Cs i.e. character, capital, capacity, conditions and collateral are basically a set of tools which are utilized by most traditional lenders to assess the creditworthiness of prospective small-business owners or borrowers. It is immensely important to know your five Cs, whether you are a borrower or a loan giver.
The 5 Cs explained:
Character:
Character simply signifies your ability to repay your debts and how you've fared at the same in past. A lender sees your credit score from credit reports to judge your creditworthiness. These credit reports have details about your past borrowings, loans that you may have or may have not repaid in time, bankruptcies if any, etc. In general, the greater your credit score, the more chances you have of getting your loan approved.
Capacity:
Capacity assesses the borrower's capability of repaying the loan he is applying for. Capacity is commonly assessed by the DTI or debt-to-income ratio of the person applying for a loan. The loan applicant’s total debt payments are divided by his monthly income to arrive at the DTI. If one has a low the DTI, his or her chances of securing the said loan, are better. An average 35% or less DTI is considered good, though all lenders have different figures at which they are willing to give the loan. Along with DTI, the job stability of the loan applicant is also taken into consideration.
Capital:
This is simply the money a borrower may have invested into a business venture. Lenders and banks are happier to give loans to individuals who have invested a sizeable chunk of their money in the business. These investments are mostly made from personal savings of small business owners. To be able to secure a loan, you need to have a record to show that this investment was made from your own money.
Conditions:
This C refers to the state or condition of your business - whether it is booming and growing or if it is making losses. The current state of the economy and other industry-related trends are also taken into consideration, as they may impact your capability of loan repayment. If your business is doing well you are likely to get the loan as the risk involved for the lender is less. It is best for small business owners to apply for loans when they don't actually need it and when the business is going good. When the conditions are bad, the credit line may get reduced.
Collateral:
The assets that you are willing to use as a guarantee to get a loan are the collaterals. These can range from a house to any equipment of value. If the borrower defaults, the lender has an assurance that he can get possession of the collateral and get his money back. This is usually the object the borrower is borrowing money for. For example in car loans, the collateral is the car itself, and a mortgage has the house as the collateral. Such loans are usually available at lower interest rates.
These 5 Cs may or may not be followed to the T, as some lenders give more importance to one of these above others, but most loan givers' criteria of weighing your creditworthiness revolve around these.
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