The 5 Cs of Credit

Your lender knows them—shouldn’t you?

A couple looks over data on a laptop screen while a lender or financial advisor explains.
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When you apply for a mortgage loan, personal loan, business loan, or any other type of financing, your lender will use your credit history to evaluate your risk as a borrower. They want to know how likely you are to repay the loan. 

But it’s not just your numerical credit score that matters during this evaluation. 

In fact, there are actually five factors of creditworthiness that a lender will look at, dubbed the “5 Cs.” Understanding these factors, as well as how they influence your overall credit picture, can help you better prepare for your loan application and ensure financing success.

1. Character

Your credit “character” speaks to your overall trustworthiness as a borrower. Can you be reasonably expected to repay your loan? Will you make your payments on time, every time, month after month? 

Your credit score and credit history both play big roles in the character aspect. Specifically, lenders want to see:

  • A long history of using credit (cards, loans, etc.)
  • Consistent, on-time payments across all accounts
  • All current credit accounts in good standing (not overdue or in collections)

If you’re applying for a business loan or other professional-related financing, evaluating character might also entail verifying your business license and other credentials, looking into your employment and business history, and understanding your educational accomplishments. 

2. Capacity

Capacity is also often referred to as “cash flow” and it’s the barometer for how well you can manage your future loan payments. To assess this, lenders will look at your income (either as an individual or as a business), as well as the stability of that income. Your debt-to-income ratio—both currently and after your new loan—will also play a role.

3. Collateral

When you borrow a significant amount of money, the lender needs to know they’re protected if you don’t repay those funds. Collateral—or assets that can be sold and used as a back-up source of repayment—offers just such protection. 

In the case of a mortgage loan, the collateral is the home itself. If you don’t make your mortgage payments, the lender can foreclose on the home, sell it off, and recoup their lost funds. Other sources of collateral might be:

  • Cash or checking and savings account balances
  • Business inventory or equipment
  • Cars
  • Real estate
  • Unpaid invoices

4. Capital

Capital is essentially how much skin you have in the game. To assess this, the lender will look at the investments made in your business, as well as things like the equipment and inventory you’ve purchased. If you’re applying for financing for a car or house, they’ll look at the down payment you’re putting toward the purchase. 

Basically, lenders want to see that you’re putting your money on the line just as you want them to. Think of it like this: if you don’t believe in your business or big-ticket purchase enough to invest in it, why should they?

5. Conditions

This one has more to do with outside factors than your own personal finances. The lender will consider things like:

  • The economy
  • Your industry (if applying for a business loan)
  • The stability of your business or job
  • The market for the product you’re buying (the housing market, for example)

The lender will also take into account how you’re going to use the money they lend you. Will it be used for renovating a home? Hiring new employees? Purchasing new equipment? They want to see that you’re making smart financial decisions that will improve the business for the long haul.

What Will Your Lender See?

If you want to understand what a lender might see when evaluating your application, start by pulling your credit report. You’re entitled to one free credit report annually from all three credit bureaus—Experian, TransUnion, and Equifax. To start, go to AnnualCreditReport.com. 

Want a better shot at landing the loan? Take steps to improve your credit picture before applying for a loan:

  • Pay your bills on time, month after month (automate your payments if necessary)
  • Reduce your debts where possible
  • Avoid opening any new accounts or cards until after your loan is funded
  • Increase your savings balances
  • Request a credit limit increase on your existing cards (but don’t use it)