How do lenders decide whether or not to loan you money? Many look at “The 5 Cs” of credit.
When lenders evaluate character, they look at stability — for example, how long you’ve lived at your current address, how long you’ve been in your current job, and whether you have a good record of paying your bills on time and in full.
Your other debts and expenses could impact your ability to repay the loan. Creditors therefore evaluate your debt-to-income ratio, that is, how much you owe compared to how much you earn. The lower your ratio, the more confident creditors will be in your capacity to repay the money you borrow.
Capital refers to your net worth — the value of your assets minus your liabilities. In simple terms, how much you own (for example, car, real estate, cash, and investments) minus how much you owe.
Collateral refers to any asset of a borrower (for example, a home) that a lender has a right to take ownership of and use to pay the debt if the borrower is unable to make the loan payments as agreed.
Some lenders may require a guarantee in addition to collateral. A guarantee means that another person signs a document promising to repay the loan if you can’t.
Lenders might consider a number of outside circumstances that may affect the borrower’s financial situation and ability to repay, for example what’s happening in the local economy.
Some lenders develop loan decision “scorecards” using the 5 C’s and other factors.
Learn about credit in the topic Using Credit to Your Advantage.
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