Have you ever wondered how a lender determines whether or not a loan applicant is worth the risk? That is to say, what are the key factors that go into gauging the creditworthiness of a potential borrower? There are 5 C’s associated with the system that a lending institution will use to analyze whether or not a borrower is worth the risk. The five C’s are character, capacity, capital, collateral, and conditions. The system is designed to assess the borrower in conjunction with the loan itself. Below, we break down each of the 5 C’s of lending.
In terms of this first C, a lender will dig deep into the borrower’s credit history. What does their credit report contain? And what type of pattern does their credit history indicate? In other words, are there a series of late payments or defaults? Do they have a bankruptcy? Are there any other red flags suggesting that this particular applicant is too much of a risk?
The lender will usually have a minimum credit score requirement when applying for any small business loan. Of course, this is not to say that you are automatically disqualified if you don’t meet that requirement. When working with an alternative or online lender, they will generally take a big picture approach versus fixating on anyone’s score. However, given this first C of lending, you want to ensure that you are actively improving your credit score if it’s not where it needs to be. Check your credit report from time to time. Ensure that there are no inaccuracies or errors; if there are, fix them immediately. And determine which debts you can start paying off now, thereby decreasing your total amount of liability.
Depending on the loan type, you may be required to put down capital. For example, if you can provide a sizeable down payment on the loan, this obviously will decrease the risk of default. You become a more attractive loan applicant. The size of your down payment will also directly impact your loan terms. The higher the capital amount, the more favorable the interest rate, for example, you might receive.
Capacity refers to your ability to pay back any business loan that you are approved for. To determine borrower capacity, the lender will assess your debt-to-income ratio. A debt-to-income ratio compares your income against regular debts that you have. Most often, a lender will want to see a lower debt-to-income ratio; ideally, you want to be around 35% or less to be approved for financing.
Collateral is a way to help you secure a loan. Collateral could take the form of real estate, vehicles or machinery, or other such assets. If you do default, the lender would then seize the collateral you have put up and try and sell it. A loan backed by collateral is known as a secured loan and is considered less risky for a lender. So do keep in mind that collateral can help you get a small business loan if other areas of your application happen to be lacking.
As mentioned, a lender will look at all of the 5 C’s of lending to include the actual conditions of the loan itself. Common conditions usually have the interest rate, the overall loan terms, and more general conditions that affect your specific industry and inquiring about what you intend to use the loan proceeds for. It is thus essential to have a definitive plan in mind.
While failing to meet the criteria implied by any of the 5 C’s of lending does not necessarily disqualify you from getting a loan, making sure that everything is where it needs to be it’s certainly going to be to your advantage. Check that credit report. Pay down some of your higher-interest debts. If you have collateral available, consider using it to secure the loan. You want to present a compelling case to a lender and, in this way, put yourself in the best position possible for loan approval.
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We work with small businesses across the US. Our job is to help you thrive and grow; this is why we offer fast and flexible loan programs designed specifically for small businesses. With short-term loans, lines of credit, and SBA loans, among other financing options, we have the resources you need. Call today, and let’s get started.