Loading the player...

What are the 'Five Cs Of Credit'

The five C's of credit is a system used by lenders to gauge the creditworthiness of potential borrowers. The system weighs five characteristics of the borrower and conditions of the loan, attempting to estimate the chance of default. The five C's of credit are character, capacity, capital, collateral and conditions.

BREAKING DOWN 'Five Cs Of Credit'

The five C's of credit method of evaluating a borrower incorporates both qualitative and quantitative measures. Lenders look at a borrower's credit reports, credit score, income statements and other documents relevant to the borrower's financial situation, and they also consider information about the loan itself.

Character

Sometimes called credit history, the first C refers to a borrower's reputation or track record for repaying debts. This information appears on the borrower's credit reports. Generated by the three major credit bureaus – Experian, TransUnion and Equifax – credit reports contain detailed information about how much an applicant has borrowed in the past and whether he has repaid his 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

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.

Capital

Lenders also consider any capital the borrower puts toward a potential investment. A large contribution by the borrower decreases the chance of default. For example, borrowers who have a down payment for a home typically find it 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.

Collateral

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

Conditions

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.

For more on the five C's, find out why banks use the five C's of credit to determine a borrower's creditworthiness.

RELATED TERMS
  1. Personal Interest

    Personal interest is interest that individuals pay on personal ...
  2. Unsecured Loan

    An unsecured loan is a loan that is issued and supported only ...
  3. Credit Limit

    Credit limit is the amount of credit that a financial institution ...
  4. Collateralization

    Collateralization occurs when a borrower pledges an asset as ...
  5. Asset Financing

    Asset financing uses a company’s balance sheet assets, including ...
  6. Evergreen Loan

    An evergreen loan is a loan that does not require the principal ...
Related Articles
  1. Small Business

    Lending Clubs: Better Than Banks?

    If you need to borrow money and your credit is making it tough, this new option may be just what you're looking for.
  2. Personal Finance

    What Is Collateral?

    Collateral is property or other assets that a borrower offers a lender to secure a loan. If the borrower stops making the promised loan payments, the lender can seize the collateral to recoup ...
  3. Personal Finance

    Getting A Mortgage: How The Process Has Changed

    After the banking crisis, banks have tightened their lending standards. Find out how the current mortgage-lending standards have changed in the last five years.
  4. Personal Finance

    Home Improvement Loans: What Are Your Best Options?

    If you plan on taking out a home improvement loan, you should know what your options are and which ones might be best for your situation.
  5. Personal Finance

    How To Overcome Bad Credit

    Some lenders can look overlook your credit score and assess other factors that fairly determine if you are a reasonable credit risk.
  6. Small Business

    Small Business Loan Vs Line of Credit: How They Differ

    Understand the differences between a small business loan and a line of credit, and learn some of the most appropriate uses for each form of financing.
  7. Personal Finance

    What Lenders Look at on Your Credit Report

    What do lenders consider when they look at your credit report? Well, a lot of things.
  8. Personal Finance

    The Basics of Credit When Starting Out

    For those starting out, it is important to be consistent and responsible in establishing good credit.
  9. Personal Finance

    These 4 Moves Will Get You OK'd for a Bank Loan

    There’s no secret trick to getting approved for a bank loan, but there are some things you can do to put your best foot forward financially when applying.
RELATED FAQS
  1. What is the difference between a loan and a line of credit?

    Understand how to differentiate between lines of credit and standard loans. Then determine which works best for your borrowing ... Read Answer >>
  2. Does inflation favor lenders or borrowers?

    Find out under what circumstances inflation benefits borrowers more than lenders and in which situations inflation can be ... Read Answer >>
Trading Center