The 5Cs have long been used by lenders to evaluate the creditworthiness of both businesses and individuals. And, while they play a big part in the decision-making process, banks like Plaza Park make their decisions based on more than these five factors.
If you’re preparing to apply for a loan, knowing your creditworthiness will help you find a loan type, rate and bank that is right for your unique situation.
Collateral is a form of security for the lender and is defined by what you own and can pledge as a type of insurance for the loan. Lenders evaluate these assets that can support your repayment. While cash is always the primary source of repayment for a loan, pledged assets can offer a secondary source. These assets can include land, equipment, vehicles and marketable securities such as stocks or bonds. Any loans that you have against any of these assets will be deducted from your collateral total.
While capacity has long been defined as your ability to repay the loan, today it has become almost synonymous with cash flow. There has been a market shift since the real estate crash of 2008 that has made cash flow the most critical metric lenders use in the evaluation process.
When a lender evaluates your cash flow, they’ll begin by evaluating your financial statements and tax returns for the past three years. They’ll use a series of key metrics, such as debt-to-income ratio or past payment history, to determine the probability that you’ll successfully repay the loan.
Character is the overall impression you make on the lender. It’s true, character is subjective, which is why having a relationship with your banker is so important. Background, experience, reputation and personal credit all play a part in a lender’s assessment of character. Not unlike other businesses, lenders are interested in working with individuals who are forthright, honest and have a solid track record. The past eight years have proven that even the best laid plans can fall through and people can fall on hard times. People that have relationships with their bankers can more often find solutions to be resilient during trials.
Like we mentioned with collateral, cash is always the best indication of the ability to repay a loan. Capital refers to the savings, investments and other assets that can help you repay the loan. These are assets that are liquid and do not have loans against them.
The conditions of a loan include things like the rate, terms and amount of principal. Lenders look at these factors and how they affect your ability to repay the loan. If conditions are unfavorable, lenders will often require you to compensate with more capital or collateral.
Evaluating your creditworthiness is not one-dimensional, and while these 5C’s are important, good banks will make lending decisions based on more than just these factors. By knowing where you stand with these factors, you and your lender can take the steps needed to position you for future success.
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