The 5 C’s of Credit - How To Dazzle The Banks For More Borrowing Power
How does lending work?
Thinking about applying for a loan this year? Whether it’s for a mortgage, a business loan or asset finance, it’s a good idea to think ahead and consider what the banks look at when you apply for credit.
Heard of the Five C’s of diamonds? It’s a framework for assessing the quality of a diamond, with the factors being colour, cut, clarity, carat weight, and certification.
In a similar vein to this, banks will typically follow what is called the ‘Five Cs of Credit’ to assess the quality (or level of risk) in a loan applicant.
They are: Character, Capacity, Collateral, Capital, and Conditions.
While it might sound simple, this framework is a good way to determine the level of risk associated with providing finance.
Let’s have a look at each of these categories:
Character: The borrower’s willingness to meet their credit obligations. How reliable is the borrower to make repayments on their debt? To look at this, the banks review your credit report with your borrowing history and enquiries.
Capacity: This is how the banks assess whether you can repay the lending. They look at your historical, current, and future cashflows (e.g. tax returns and payslips), and consider your personal circumstances, e.g. married/single, no dependants or dependants and assess your living expenses.
Collateral: Another term here is security; this is the asset that is pledged to the bank to support the lending. Banks are now matching the purpose of the borrowing to the collateral profile.
Capital: This is the value of the assets that the borrower owns. The banks like to see a person’s net position with assets and their liabilities. Another term you might know is equity - this is the asset value less any loan amount.
Conditions: The conditions of your loan such as the interest rate, term, and any other covenants that might apply to your lending. For example, 30 years and the interest rate applicable.
What you can do to improve your borrowing power
-Save for a deposit.
-Cut back on spending
-Reduce or close credit cards, Afterpay, or buy now/pay later facilities.
-Speak to a mortgage broker, who can help to assess your situation, identify the best loans for your circumstances, and determine a plan to dazzle the banks with your 5 C’s.
Got a question or want to know more about improving your chances of achieving that loan? Reach out to Kathryn at Barwon Mortgages to book your free consultation.