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What are the 4 Cs of Credit and how does the SBA evaluate them?

when evaluating business plans are primarily concerned with the four cs of credit

     If you're a small business owner looking to secure financing , you've likely heard the term "4 Cs of Credit" before. But what are they, and how do they relate to the Small Business Administration 's (SBA) evaluation process? Let's dive in.

     The 4 Cs of Credit refer to four key factors that lenders consider when assessing a borrower's creditworthiness. These factors are:

Let's take a closer look at each of these factors and how they come into play.

    Character involves a borrower's reputation and track record. Essentially, it's an assessment of whether the borrower can be trusted to repay the loan. Lenders will evaluate a borrower's credit history, including factors like credit score, payment history, and any past bankruptcies or foreclosures. They'll also consider the borrower's experience in the industry and their overall business acumen.

    From the SBA 's perspective, character is evaluated through a combination of credit history, references, and personal and business background checks. The SBA will also consider the borrower's level of commitment to the business, including their willingness to personally guarantee the loan .

    Capacity refers to a borrower's ability to repay the loan. Lenders will assess the borrower's income, cash flow, and debt-to-income ratio to determine whether they have the financial resources to make timely loan payments. This is an important consideration for lenders, as they want to ensure that they're not putting the borrower in a situation where they're unable to make payments and default on the loan.

    When it comes to the SBA's evaluation process, capacity is evaluated through a thorough analysis of the borrower's financial statements and projections. The SBA will want to see evidence that the borrower has a solid plan in place to generate enough revenue to make loan payments on time.

    The borrower's capital represents his or her investment in the business. This includes not only the borrower's initial investment but also any additional investments they've made over time. Lenders want to see that the borrower has a stake in the business and that they're committed to its success. This can help to mitigate the lender's risk, as the borrower has something to lose if the business fails.

    From the SBA 's perspective, capital is evaluated by assessing the borrower's equity position in the business. The SBA will want to see evidence that the borrower has invested a significant amount of their own money in the business, as this demonstrates their commitment to its success.

    Loans are secured by collateral, which is the borrower's pledged assets. In the event that the borrower is unable to make payments, the lender can seize these assets to recoup their losses. Collateral can come in many forms, including real estate, equipment, inventory, and accounts receivable.

    When it comes to the SBA's evaluation process, collateral is evaluated by assessing the value and quality of the assets being pledged. The SBA will want to see that the collateral is sufficient to cover the loan amount in the event of default.

    So, how does the SBA evaluate the 4 Cs of Credit in practice? Let's take a look at an example.

     Say you're a small business owner looking to secure an SBA loan to expand your operations. Here's how the SBA might evaluate the 4 Cs of Credit in your case:

    The SBA evaluates your credit history, references, and personal and business background checks to assess your character. They might look for evidence that you have a good track record of repaying debts and a strong level of business acumen.

    In order to assess your capacity, the SBA would examine your financial statements and projections. They would want to see evidence that you have a solid plan in place to generate enough revenue to make loan payments on time. This includes analyzing your cash flow, debt-to-income ratio, and other financial metrics to ensure that you have the resources to repay the loan.

   A capital assessment is conducted by the SBA based on your equity position in the business. They would want to see evidence that you've invested a significant amount of your own money in the business and that you have a stake in its success. This consists of analyzing your balance sheet and other financial statements to determine your level of investment.

   The SBA would evaluate the assets you're pledging as collateral to assess their value and quality. They would want to see evidence that the collateral is sufficient to cover the loan amount in the event of default. The process includes analyzing the value of your real estate, equipment, inventory, and accounts receivable, among other assets.

when evaluating business plans are primarily concerned with the four cs of credit

    Overall, the SBA's evaluation process is designed to assess the borrower's creditworthiness based on a variety of factors, including their character, capacity, capital, and collateral. By evaluating these factors in depth, the SBA can make informed decisions about which borrowers are most likely to succeed and repay their loans.

     It's worth noting that the 4 Cs of Credit aren't the only factors that lenders and the SBA consider when evaluating loan applications. Other factors, such as industry trends, economic conditions, and the borrower's business plan, can also play a role in the evaluation process.

    If you're a small business owner looking to secure financing , it's important to understand the factors that lenders and the SBA consider when evaluating loan applications. By focusing on building your creditworthiness, demonstrating your financial capacity, investing in your business, and providing collateral, you can improve your chances of securing the financing you need to grow and succeed.

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The 4 C's of Credit for Business Loans

Character - Capacity - Collateral - Capital

SDI Productions / Getty Images 

Banks look carefully at borrowers before they lend money, especially in tough financial times like these. 

The #1 reason banks say no to small business loans is "credit," both poor credit and lack of credit. 

Although the general credit principles are the same, lenders look at business loans differently from personal loans. The lender looks primarily at the credit of the business. That's fine for an existing business, but what about a startup business? In this case, the lender must include the credit of the business owner. 

Because business loans are the riskiest of any loan, lenders are much more strict with their criteria. Don't be surprised if your personal credit history is scrutinized, as well as the credit of the business. 

What bankers look for in their approval process for business loans can be summarized in the following criteria, termed the "4 C's of Credit." 

Character of Borrower

Character refers to the financial history of the borrower; that is, what kind of "financial citizen" is this person or business? Character is most often determined by looking at the credit history, particularly as it is stated in the credit score (FICO score). Factors that will affect your credit score include: The fewer the problems, the higher the credit score. A high personal credit score (over 700) may be the most important factor in getting a business loan. Some factors that affect your credit score include:

  • Late payments
  • Delinquent accounts
  • Available credit

Business and personal credit are two different things. Most new businesses have no business credit, so they must use the personal credit of their owners. In such situations as business loans and leases, the owner may need to give a personal guarantee.

Capacity to Repay

Capacity refers to the ability of the business to generate revenues to pay back the loan. Since a new business has no "track record" of profits, it is riskiest for a bank to consider. If you are buying a business, capacity is easier to determine, and a business that can show a positive cash flow (where income exceeds expenses) for a sustained period of time has a good chance of getting a business loan.

Capital Assets of Business

Capital refers to the capital assets of the business. Capital assets  might include machinery and equipment for a manufacturing company, as well as product inventory, or store or restaurant fixtures. Banks consider capital, but with some hesitation, because if your business folds, they are left with assets that have depreciated and they must find someplace to sell these assets, at liquidation value. You can see why, to a bank, cash is the best asset.

Collateral to Secure the Loan

Collateral is the cash and assets a business owner pledges to secure a loan. In addition to having good credit, a proven ability to make money, and business assets, banks will often require an owner to pledge their own personal assets as security for the loan.

Banks require collateral because they want the business owner to suffer if the business fails. If an owner didn't have to put up any personal assets, they might walk away from the business failure and let the bank take what it can from the assets. Having collateral at risk makes the business owner more likely to work to keep the business going, as banks reason it.

Adding up the 4 C's of Credit

As you can see, when it comes to credit, the old saying that "banks only loan money to people who don't need it" is true. To get a business loan, you will need to:​

  • Have an excellent credit rating, both personal and business
  • Prove your business will generate revenues to pay the bank loan
  • Show that the business assets have value in case they need to be sold to pay off the bank
  • Pledge your assets in case the business fails or get a co-signer who has assets to pledge. 

In some cases, it might be easier to take your own money and start your business.

when evaluating business plans are primarily concerned with the four cs of credit

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The 5 C’s of Credit: What They Are, How to Build Them

Rosalie Murphy

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The five C’s, or characteristics, of credit — character, capacity, capital, conditions and collateral — are a framework used by many lenders to evaluate potential small-business borrowers.

Each of the five C’s plays into what small-business loans you can qualify for. But different lenders may place more value on one characteristic than another. Because there are no strict guidelines, it can be helpful to understand your business's relative strengths and weaknesses — especially since factors like rising business loan interest rates are out of your control.

Here are the five C’s of credit and some tips for putting your best foot forward with each.

The five C's of credit

Capacity/Cash flow.

Conditions.

Collateral.

Chase Ink Business Cash Credit Card Credit Card

Ink Business Cash® Credit Card

1. Character

What it is: A lender’s opinion of a borrower’s general creditworthiness.

Why it matters: Lenders want to see a history of on-time and full debt repayment.

How it’s assessed: From factors like your credit history, credentials, references and interaction with lenders.

How to strengthen it: Know what lenders will see with your personal credit, which will likely be the most important part of this C. Your personal credit offers a quick look at your history of borrowing and repaying money. Lenders want this information because most will require you to personally guarantee the debt — meaning you have to repay it if your business can’t.

If you’re unsure about your personal credit, you can review your reports for free once a year at AnnualCreditReport.com. You can also get a free score online from multiple places, including NerdWallet . If you need to build your personal credit , strategies to do so include getting a secured credit card or credit-builder loan and keeping your credit utilization relatively low.

Growing your business credit score can help with character, too (a straightforward first step might be to get a business credit card ). Business credit is based on your company's history with debt repayment, not your personal history. It can give lenders an additional piece of information that supports your company’s creditworthiness, even if they don’t know your personal reputation.

You can help a lender understand that reputation by establishing a relationship with them over time. Typically, this is easiest to do if you use a small-business bank , in particular one with a local or community presence. Bankers who know your business’s history — and your personal reputation — may be more willing to work with you even if your other C’s are less strong.

How to work around it: Online lenders tend to place a higher premium on your business finances and may have more wiggle room around personal characteristics like credit score.

2. Capacity/cash flow

What it is: Your ability to repay the loan.

Why it matters: Lenders want to be assured that your business generates enough cash flow to repay the loan in full.

How it’s assessed: From financial metrics and benchmarks (debt and liquidity ratios, cash flow statements), credit score, borrowing and repayment history.

How to strengthen it: If you’re focusing on bank business loans , pay down debt before you apply to free up more cash flow.

If your cash flow is strong but your other C’s are lacking, consider cash flow loans , which prioritize this factor when reviewing your application. Cash flow lenders may want to review documents like your bank statements and merchant accounts, but give less weight to your credit history or time in business. These loans are most commonly available from online and alternative lenders and tend to have higher interest rates than business term loans.

How to work around it: Is your cash flow uneven? A business line of credit or business credit card might be a good next step. These financing products let you borrow a little money at a time, pay it off and pay interest only on what you’ve borrowed. And repayment may be easier to manage than the fixed payments most term loans require.

» MORE: 7 things you’ll need to qualify for a small-business loan

What it is: The amount of money invested in a business by its owner or management team.

Why it matters: Lenders are more willing to offer financing to owners who have invested some of their own money into the venture. It shows you have some skin in the game, so to speak.

How it’s assessed: From the amount of money the borrower or management team has invested in the business.

How to strengthen it: Nearly 70% of small-business owners use personal savings to start their business, according to a 2023 survey from the U.S. Chamber of Commerce. [0] U.S. Chamber of Commerce . New Survey Shows Small Businesses’ Growing Concern about Raising Capital . View all sources Make sure you categorize any personal investments in your business accurately in your accounting software , so you can keep track of them later.

How to work around it: You don’t need to immediately funnel your life savings into your business. Startup business credit cards can be a useful tool for building your business early on — though you will likely be personally on the hook to pay off any balance your business can’t . Once you have six months to a year in business, you’ll start to qualify for additional startup business loan options.

4. Conditions

What it is: The condition of your business — whether it is growing or faltering — as well as what you’ll use the funds for. It also considers the state of the economy, industry trends and how these factors might affect your ability to repay the loan.

Why it matters: Operating under favorable conditions can help ensure businesses repay their loans. Lenders aim to identify risks and protect themselves accordingly.

How it’s assessed: From a review of the competitive landscape, supplier and customer relationships, and macroeconomic and industry-specific issues.

How to strengthen it: You can’t control the economy, but you can try to plan ahead. Although it might seem counterintuitive, apply for a business line of credit before you need it , when your business is strong. That will give you access to flexible financing down the road if your business’s conditions change.

How to work around it: It’s understandable to feel stressed when your business hits a rough patch, and you might want financing fast as a result. But when this C is a weakness, it’s especially important to take your time and shop around because you’ll have fewer financing options and they may be more expensive.

» MORE: Is your business software provider offering you a loan? Ask these questions first

5. Collateral

What it is: Assets that are used to guarantee or secure a loan.

Why it matters: Collateral is a backup source if the borrower cannot repay a loan.

How it’s assessed: From hard assets, such as real estate and equipment; working capital, such as accounts receivable and inventory; and a borrower’s home, which also can be counted as collateral.

How to strengthen it: Understand what options you have to collateralize . While real estate is common, you can also secure a loan with equipment, inventory, accounts receivable, vehicles or other business assets.

Many lenders also file a UCC lien , which gives them the right to seize a borrower’s assets if they default on their loan. Picking the right business structure can help protect your personal assets from a lender that is trying to collect.

How to work around it: SBA loans and business bank loans generally require collateral. If you don’t have collateral, unsecured business loans don’t require it — though they do usually require a personal guarantee and place UCC liens on borrowers. And unsecured financing can be more expensive since it’s riskier for lenders.

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Level 1 CFA® Exam: Four Cs of Credit Analysis & Credit Ratios

Cfa exam: 4 cs of credit analysis.

The 4 Cs of credit analysis include:

  • collateral,
  • covenants, and
  • Capacity is the ability of the issuer to make debt payments according to the payment schedule.

To analyze the capacity of the issuer to service its debt, the credit analysts use the following process:

  • Analyzing industry structure (e.g. using Porter's five forces).
  • Analyzing industry fundamentals (e.g. growth prospects, cyclical vs non-cyclical, etc.).
  • Analyzing company fundamentals (e.g. competitive position, operating history, management’s strategy & execution, ratio analysis, etc.)
  • Collateral is the quality and value of the assets that serve as collateral for the issued debt.

Assets of a company vary in value, e.g. intangible assets like goodwill should be perceived as assets of lower quality. What is more, for publicly traded companies, if the market value is below the book value, it should be perceived as a warning sign.

  • Covenants are terms and conditions of lending agreements, introduced to protect creditors, that the borrower has to comply with.

We distinguish between negative covenants which state what the issuer cannot do and affirmative covenants which state what the issuer must do .

CFA Exam: Financial Ratios Used in Credit Analysis

Here are 4 financial ratios used in credit analysis that you should know in your level 1 CFA exam:

Leverage Ratios

\(DTC = \frac{\text{debt}}{\text{debt} + \text{equity}}\)

  • \(DTC\) - debt-to-capital ratio
  • \(\text{debt}\) - total debt
  • \(\text{equity}\) - total shareholders' equity

Measures: what percentage of the company's capital is financed with debt.

Interpretation, relations, and usage:

the higher the ratio >> the higher the financial risk >> the weaker the solvency

'total debt' is defined as interest-bearing short-term debt + interest-bearing long-term debt

\(\text{FFO-to-Debt} = \frac{FFO}{\text{total debt}}\)

  • \(\text{FFO-to-Debt}\) - funds from operations to debt ratio
  • \(FFO\) - funds from operations

FFO = funds from operations = EBITDA – net interest expense – current tax expense

Coverage Ratios

\(\text{interest coverage} = \frac{EBIT}{\text{interest payments}}\)

  • \(EBIT\) - earnings before deducting interest and taxes

Measures: how many times EBIT is higher than interest payments

the higher the ratio >> the higher the solvency

the higher the ratio >> the easier for the company to service its debt from its operating earnings

\(IC_{EBITDA} = \frac{EBITDA}{\text{interest expense}}\)

  • \(IC_{EBITDA}\) - EBITDA interest coverage
  • \(EBITDA\) - earnings before interest, taxes, depreciation, and amortization
  • \(\text{interest expense}\) - interest expense ( including nonË—cash interest on conventional debt instruments )

Credit Quality of Issuer/Bond in Comparison to Industry

In your CFA exam, you might be asked to compare the credit quality of a company in comparison to the industry using different ratios. To do this right, always pay attention to the form of a given ratio, i.e. what’s in the numerator and what’s in the denominator.

Level 1 CFA Exam Takeaways: Four Cs of Credit Analysis & Credit Ratios

  • The 4 Cs of credit analysis include capacity, collateral, covenants, and character.
  • We distinguish between negative and affirmative covenants.
  • Character is the quality of the issuer’s management.
  • For debt ratios if debt is given in the denominator of the ratio, then the higher the ratio, the higher the credit quality, and vice versa. If debt is given in the numerator of the ratio, then the higher the ratio, the lower the credit quality.
  • For coverage ratios, the higher the ratio, the higher the credit quality.

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The four Cs of credit: What are the banks looking for?

The fours Cs of credit are a common set of principles that banks and lenders consider when assessing business loan applications.

2022-07-11 00:00

The fours Cs of credit are a common set of principles that banks and lenders consider when assessing business loan applications. The four Cs not only help the lender understand your business needs but can also help you when applying for finance.

1. Character

Although it’s called character, the first principle has nothing to do with personality. This refers to an applicant’s business acumen, reputation, credit history and track record to repay debt.

A lender will assess the background of the business owner/s and shareholders, and their experience. Also considered are the primary activities of the business and the environment they operate within, including time in industry, industry trends and business location.

A few other things that a lender may look at include:

  • your personal and business credit history
  • your tax returns and financial history
  • whether you’ve paid off previous loans
  • other factors such as job stability, previous businesses or any legal issues.
  • Check your credit profile; visit MoneySmart for more resources.
  • Check your online reputation; does your website and social media account accurately reflect the business?

2. Capacity

Put simply, this determines if a business has the means to repay debt. The lender will assess the borrower’s ability to repay the debt by reviewing several items including previous bank statements, other loans and understanding the strategy of where you plan on taking your business, and if the business trade is seasonal.

If the business is already established, previous Profit and Loss Statements will be reviewed. A lender may also consider any trend in the current and previous financial year data. Many start-ups have a lot of expenses in the first year, so the second year of trade may show a better picture.

It’s in everyone’s interest to ensure the borrower can comfortably afford to repay the loan without incurring hardship, so providing as much information as possible helps.

  • Review and update your business plan (if you don’t already have one you can use our ANZ Business Plan Template ).
  • Ensure documentation is up to date. Use this handy business lending checklist .

3. Collateral

Collateral is an item or asset of value that is typically used to secure the loan, such as cash, property, land or accounts receivable.  The lender may take into consideration the age, location and attributes of the security. You may be required to provide details of the assets so the lender can determine its current and future value.

Collateral is not required for an unsecured loan but it may improve your chances of being approved or help reduce your interest rates.

  • Create a balance sheet to identify your current assets.
  • Provide up-to-date valuations of your assets.

Lenders will look at the borrower’s overall financial position including:

  • assets and liabilities
  • any deposit or borrower’s contribution they are willing to make

Capital is the additional security used if the borrower finds they are unable to repay the loan.

Capital includes assets such as cash, equipment, machinery and investments already made into the business.

The current value and potential future value of the capital will be considered should it need to be sold off in the event you are unable to repay the loan.

  • Complete a break-even calculation and cash flow forecast so you know how much extra you’ll need to sell to cover your repayments.

Speak to an ANZ Business Banker

When applying for a loan, it is important to be informed, prepared and in good shape to borrow. But another ace up your sleeve is a great relationship with an ANZ Business Banker.

ANZ offer a range of finance solutions that may suit a variety of needs, so as soon as you are thinking of borrowing, start a conversation early with us to see how we can help.

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PCM CORP | Priority Credit Management Corp.

The 4 Cs of Credit

The decision to extend payment terms to a new customer is based around the 4 Cs of credit granting:

  • Creditworthiness

The weight to which creditors apply each of these principles depends upon the risk tolerance of the company extending the terms.

Small firms start by heavily relying upon their knowledge of their customer’s character because they do not usually have access to credit bureaus. As a company grows and the owner begins to lose personal touch with each new customer, indicators such as creditworthiness become much more essential.

Tools like Credit Reports and Credit Scoring must be used to get a better feel for the customer’s ability to pay.

To Find Out More Call Toll-Free 1-866-766-9195

What Are the 4 Cs of Credit?

1. character.

Someone’s character is their integrity about how they conduct their business affairs – these are people whose word is their bond. If you are lucky enough to know these individuals, you will not hesitate to extend repayment terms.

Customers with strong character competence are straight shooters and would tell you upfront they could not purchase from you if they could not afford it.

As your business continues to grow, you may lose touch with your customers, and the deals begin to flow through your sales representatives. At this point, character competence isn’t enough and your business should start to implement more decision tools to aid your sales staff .

2. Creditworthiness

The second of the 4 Cs of credit is creditworthiness. Determining your customer’s ability to pay or manage credit can be accomplished in several ways.

Your credit applications form should ask your customers for other suppliers that have extended credit. Calling credit references and inquiring about their experience with your customers can provide some level of comfort. However, the credit reference may also be your competitor, so don’t expect much cooperation from them.

Another way to check customer creditworthiness is to obtain a credit bureau report . Information from a credit bureau like Dun and Bradstreet is only as useful as the data fed into it, so be prepared to supply the bureau with your customer’s financial data. The report will tell you how your customers are paying other creditors.

Sometimes your business customer is recently incorporated, and the commercial credit file contains little or no information. In this case, it is advisable to obtain the business principals’ guarantee so you can get their credit file. People generally run their businesses like they manage their credit .

3. Cashflow

The third of the 4 Cs of credit granting is cash flow. How does your customer derive its income? Is their income consistent or seasonal? Do they operate a cash business, or do they offer repayment terms to their customers?

  • If your customer is an individual, you can ask for a copy of pay stubs or tax filings.
  • If your client is a business, you can request a copy of your customer’s income statements and balance sheet to assess your risk.

Ask what payment terms they extend to their clients . If your customer’s client is a large oil producer, that pays at 90 days, and your terms are 30 days, then your customers should have access to a line of credit at their bank. Otherwise, you’ll have to wait until the oil producer pays its bills to your customer.

4. Conditions

Conditions are the most often overlooked of the 4 Cs of credit granting. In the example above under cash flow, the condition of the customer’s market in the petroleum industry creates the potential for your customer to become delinquent.

Seasonality is another common condition that affects those supplying to the agriculture industry or suppliers of any commodity. The demand and pricing of commodities can change overnight, leaving your customers in a precarious financial position .

Credit Control with PCM Corp

At Priority Credit Management Corp (PCM Corp), our credit control staff use all of the 4 Cs of credit granting. The 4 Cs are used to make determinations of eligibility of credit terms as well as taking our client’s appetite for risk into consideration.

  • Clients with lower margins should be more risk-averse.
  • Whereas clients with higher margins can afford more elevated levels of risk.

While the 4 Cs of credit granting will always play a crucial role when extending credit terms, the introduction of artificial intelligence (AI) will be a game-changer.

In the not too distant future, companies will be using AI to locate online information and combine it with traditional data sources to produce a credit score. Therefore we highly recommend that companies and individuals meticulously manage their online presence to avoid credit approval issues.

If you still have questions about the 4 Cs of Credit or if you wish to learn about how PCM Corp can help you manage your credit and financial risk, contact us online or call us at 1-866-766-9195 .

Bank of Labor

What Are the Four Cs of Credit?

Couple Shaking Hands with Person

When you want to borrow money, a potential creditor will take a close look at your background. As Bank of Labor’s Senior Credit Officer, Pat Thomas, notes, “This review helps banks and other creditors determine whether or not you have the means to repay the loan.”

What criteria does a lender use when assessing credit risk? Most use a framework known as the “Four Cs of Credit.” These are four common-sense areas that a creditor will review. Those four Cs are…

Here is what lenders look at when it comes to each of these factors so you can understand how they make their decisions.

Capacity refers to the borrower’s ability to pay back a loan. This is one of a creditor’s most important considerations when lending money. However, different creditors measure this ability in different ways. For example, lenders might analyze…

  • Debt-to-income (DTI) ratio, which is how much total debt you have relative to your income
  • The amount of revolving debt you have, such as credit card debt
  • How much your payments would be for the proposed loan relative to your gross monthly income

Lenders will ask for verification of your income and debt payments to ensure you have the capacity to take on a loan. They might require that you submit current pay stubs, past tax returns, or W2s. They will evaluate your income based on how long you’ve been employed with a company and the type of income you earn (salary, commission, freelance, etc.). 

Lenders will also review your recurring monthly expenses, such as…

  • Mortgage payments
  • Car payments
  • Student loans
  • Personal loans
  • Other debts
  • Credit card payments

Most lenders will use a DTI calculation as part of this assessment, with many preferring a ratio of 38% or less before approving financing. In fact, the Consumer Financial Protection Bureau (CFPB) reports that some lenders are prohibited from issuing loans to borrowers with high DTIs.

Lenders also consider any equity the borrower put towards their loan or purchase. A larger down payment may reduce the borrower’s chances of defaulting on the loan and give the lender more assurance.

In addition to any proposed down payment, lenders may consider components like cash flow and overall net worth. In other words, how much money do you have in investments and savings, and what portion of that is accessible if needed? Some sources of cash reserves might include…

  • Money market funds
  • Other investments that can be converted to cash, including bonds, Certificates of Deposit (CDs), 401(k) accounts, and Individual Retirement Accounts (IRA). 

In addition to cash reserves, other sources of capital that a lender might consider include gifts from family members, grants or matching funds programs, and closing cost assistance programs. 

Lenders are likely to ask for verification of any capital. You might need to submit copies of investment statements or documentation with your loan application. Lenders may also ask to see several months’ worth of statements for your checking and savings accounts .

Most loans require collateral. For a mortgage, the collateral would be the home; for a vehicle, it’s the car, and so on.

When a lender evaluates a loan, they consider the loan-to-value (LTV) ratio, which is the collateral’s value relative to the loan amount. For example, a 100% LTV means you are borrowing 100% of the asset’s value, likely with no down payment. 

A higher LTV is riskier for lenders. There’s always the potential that the value of an asset could fall after the loan is issued. This is particularly the case with vehicles and equipment. If you default on the loan, the lender has the legal right to repossess or foreclose on the collateral.

Most lenders will have a minimum LTV requirement to protect themselves from large losses. This often necessitates a certain down payment to lower the LTV on a potential loan.

Finally, most lenders will review a potential borrower’s character by assessing their credit history. Your credit history gives a detailed overview of how you managed debt in the past, which is a good predictor of future behavior. 

For personal loans like mortgages and car loans, lenders will obtain a report from one or more credit bureaus (Experian, Equifax, and TransUnion). These bureaus also use a program from the Fair Isaac Corporation (FICO) to assign a single score, ranging from 300 to 850, with higher scores being better.

Credit reports contain detailed information about your past borrowing activity, including whether or not you have paid loans on time and have any collection accounts, judgments, or bankruptcies. This information stays on your report for anywhere from seven to ten years. 

A good credit score is assigned based on how you manage your credit in relation to everyone else in the system. Many lenders have a minimum credit score requirement before an applicant will be considered for a loan. Your credit score can also dictate the terms you receive on your loan. 

The Other “C” of Credit

The other “C” of credit that isn’t used quite as often is “Conditions.” This refers to any external conditions surrounding the potential borrower being evaluated. In the case of a business, has the economic environment changed in any way that might impact the borrower or their industry? 

Thomas explains that conditions might also refer to how the borrower intends to use the funds. “For example,” says Thomas, “if the intended use seems significantly risky, it may impact approval of the loan.

This is far from an exhaustive list, but it should give you a better idea of how creditors assess a potential borrower before agreeing to make a loan. Each lender will have different standards, but all of them want to see that loan applicants will be able to repay any money they borrow without difficulty.

For assistance with credit questions and applications, please call Bank of Labor at 913.321.4242 .

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What Are the 5 Cs of Credit?

Understanding the 5 cs of credit, 1. character, 2. capacity, 4. collateral, 5. conditions.

  • 5 C's of Credit FAQs

The Bottom Line

  • Personal Finance

5 Cs of Credit: What They Are, How They’re Used, and Which Is Most Important

when evaluating business plans are primarily concerned with the four cs of credit

The five Cs of credit are important because lenders use these factors to determine whether to approve you for a financial product. Lenders also use these five Cs—character, capacity, capital, collateral, and conditions—to set your loan rates and loan terms.

The five Cs 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 and, consequently, the risk of a financial loss for the lender . The five Cs of credit are character, capacity, capital, collateral, and conditions.

Key Takeaways

  • The five Cs of credit are used to convey the creditworthiness of potential borrowers, starting with the applicant’s character, which is their credit history.
  • Capacity is the applicant’s debt-to-income (DTI) ratio.
  • Capital is the amount of money that an applicant has.
  • Collateral is an asset that can back or act as security for the loan.
  • Conditions are the purpose of the loan, the amount involved, and prevailing interest rates.

Joules Garcia / Investopedia

The five-Cs-of-credit method of evaluating a borrower incorporates both qualitative and quantitative measures. Lenders may look at a borrower’s credit reports, credit scores, income statements, and other documents relevant to the borrower’s financial situation. They also consider information about the loan itself.

Each lender has its own method for analyzing a borrower’s creditworthiness. Most lenders use the five Cs—character, capacity, capital, collateral, and conditions—when analyzing individual or business credit applications.

Alison Czinkota / Investopedia

Character, the first C, more specifically refers to credit history , which is a borrower’s reputation or track record for repaying debts. This information appears on the borrower’s credit reports , which are generated by the three major credit bureaus : Equifax, Experian, and TransUnion. Credit reports contain detailed information about how much an applicant has borrowed in the past and whether they have repaid loans on time.

These reports also contain information on collection accounts and bankruptcies, and they retain most information for seven to 10 years. Information from these reports helps lenders evaluate the borrower’s credit risk . For example,  FICO uses the information found on a consumer’s credit report to create a credit score , a tool that lenders use for a quick snapshot of creditworthiness before looking at credit reports.

FICO Scores range from 300 to 850 and are designed to help lenders predict the likelihood that an applicant will repay a loan on time. Other firms, such as VantageScore , a scoring system created by a collaboration of Equifax, Experian, and TransUnion, also provide information to lenders.

Many lenders have a minimum credit score requirement before an applicant is approved for a new loan. Minimum credit score requirements generally vary from lender to lender and from one loan product to the next. The general rule is the higher a borrower’s credit score, the higher the likelihood of being approved.

Lenders also regularly rely on credit scores to set the rates and terms of loans . The result is often more attractive loan offers for borrowers who have good to excellent credit. Given how crucial a good credit score and credit reports are to secure a loan, it’s worth considering one of the best credit monitoring services to ensure that this information stays safe.

Improving Your 5 Cs: Character

Prospective borrowers should ensure that credit history is correct and accurate on their credit report. Adverse, incorrect discrepancies can be detrimental to your credit history and credit score. Consider implementing automatic payments on recurring billings to ensure future obligations are paid on time. Paying monthly recurring debts and building a history of on-time payments help to build your credit score.

Capacity measures the borrower’s ability to repay a loan by comparing income against  recurring debts  and assessing the borrower’s  debt-to-income (DTI) ratio . Lenders calculate DTI by adding a borrower’s total monthly debt payments and dividing that by the borrower’s gross monthly income. The lower an applicant’s DTI, the better the chance of qualifying for a new loan.

Every lender is different, but many mortgage lenders prefer an applicant’s DTI to be around 36% or less before approving an application for new financing. It is worth noting that sometimes lenders are prohibited from issuing loans to consumers with higher DTIs as well.

For example, qualifying for a new mortgage typically requires a borrower have a DTI of 43% or lower to ensure that the borrower can comfortably afford the monthly payments for the new loan, according to the Consumer Financial Protection Bureau (CFPB) .

Improving Your 5 Cs: Capacity

You can improve your capacity by increasing your salary or wages or decreasing debt. A lender will likely want to see a history of stable income. Although switching jobs may result in higher pay, the lender may want to ensure that your job security is stable and that your pay will continue to be consistent.

Lenders may consider incorporating freelance, gig, or other supplemental income. However, income must often be stable and recurring for maximum consideration and benefit. Securing more stable income streams may improve your capacity.

Regarding debt, paying down balances will continue to improve your capacity. Refinancing debt to lower interest rates or lower monthly payments may temporarily alleviate pressure on your debt-to-income metrics, though these new loans may cost more in the long run. Be mindful that lenders may often be more interested in monthly payment obligations than in full debt balances. So, paying off an entire loan and eliminating that monthly obligation will improve your capacity.

Lien and Judgment Report

Lenders may also review a lien and judgments report, such as LexisNexis RiskView, to further assess a borrower’s risk before they issue a new loan approval.

Lenders also consider any capital that the borrower puts toward a potential investment. A large capital contribution by the borrower decreases the chance of default.

Borrowers who can put a down payment on a home, for example, typically find it easier to receive a mortgage —even special mortgages designed to make homeownership accessible to more people. For instance, loans guaranteed by the  Federal Housing Administration (FHA) may require a down payment of 3.5% or higher, and nearly 90% of all Department of Veterans Affairs (VA) -backed home loans are made without a down payment. Capital contributions indicate the borrower’s level of investment, which can make lenders more comfortable about extending credit.

Down payment size can also affect the rates and terms of a borrower’s loan. Generally, larger down payments or larger capital contributions result in better rates and terms. With mortgage loans, for example, a down payment of 20% or more should help a borrower avoid the requirement to purchase additional private mortgage insurance (PMI) .

Improving Your 5 Cs: Capital

Capital is often obtained over time, and it might take a bit more patience to build up a larger down payment on a major purchase. Depending on your purchasing time line, you may want to ensure that your down payment savings are yielding growth, such as through investments. Some investors with a long investment horizon may consider placing their capital in index funds or exchange-traded funds (ETFs) for potential growth at the risk of loss of capital.

Another consideration is the timing of the major purchase. It may be more advantageous to move forward with a major purchase with a lower down payment as opposed to waiting to build capital. In many situations, the value of the asset may appreciate (such as housing prices on the rise). In these cases, it would be less beneficial to spend time building capital.

Collateral  can help a borrower secure loans. It gives the lender the assurance that if the borrower defaults on the loan, the lender can get something back by repossessing the collateral. The collateral is often the object for which one is borrowing the money: Auto loans, for instance, are secured by cars, and mortgages are secured by homes.

For this reason, collateral-backed loans are sometimes referred to as secured loans or secured debt. They are generally considered to be less risky for lenders to issue. As a result, loans that are secured by some form of collateral are commonly offered with lower interest rates and better terms  compared to other unsecured forms of financing.

Improving Your 5 Cs: Collateral

You may improve your collateral by simply entering into a specific type of loan agreement. A lender will often place a lien on specific types of assets to ensure that they have the right to recover losses in the event of your default. This collateral agreement may be a requirement for your loan.

Some other types of loans may require external collateral. For example, private, personal loans may require placing your car as collateral. For these types of loans, ensure you have assets that you can post, and remember that the bank is only entitled to these assets if you default.

In addition to examining income, lenders look at the general conditions relating to the loan. This may include the length of time that an applicant has been employed at their current job, how their industry is performing, and future job stability.

The conditions of the loan, such as the interest rate and the amount of principal , influence the lender’s desire to finance the borrower. Conditions can refer to how a borrower intends to use the money. Business loans that may provide future cash flow may have better conditions than a house renovation during a slumping housing environment in which the borrower has no intention of selling.

Additionally, lenders may consider conditions outside of the borrower’s control, such as the state of the economy, industry trends, or pending legislative changes. For companies trying to secure a loan, these uncontrollable conditions may be the prospects of key suppliers or customer financial security in the coming years.

Some consider the criteria that lenders use as the four Cs. Because conditions may be the same from one debtor to the next, it is sometimes excluded to emphasize the criteria most in control of a debtor.

Improving Your 5 Cs: Conditions

Conditions are the least likely of the five Cs to be controllable. Many conditions such as macroeconomic , global, political, or broad financial circumstances may not pertain specifically to a borrower. Instead, they may be conditions that all borrowers may face.

A borrower may be able to control some conditions. Ensure that you have a strong, solid reason for incurring debt, and be able to show how your current financial position supports it. Businesses, for example, may need to demonstrate strong prospects and healthy financial projections.

What are the 5 Cs of credit?

The five Cs of credit are character, capacity, collateral, capital, and conditions.

Why are the 5 Cs important?

Lenders use the five Cs to decide whether a loan applicant is eligible for credit and to determine related interest rates and credit limits. They help determine the riskiness of a borrower or the likelihood that the loan’s principal and interest will be repaid in a full and timely manner.

Which of the 5 Cs is the most important?

Each of the five Cs has its own value, and each should be considered important. Some lenders may carry more weight for categories than others based on prevailing circumstances.

Character and capacity are often most important for determining whether a lender will extend credit. Banks utilizing debt-to-income (DTI) ratios, household income limits, credit score minimums, or other metrics will usually look at these two categories. Though the size of a down payment or collateral will help improve loan terms, these two are often not the primary factors in how a lender determines whether to expend credit.

Which of the 5 Cs refers to an individual’s credit history?

Character refers to the composition of a borrower’s financial history and financial health. Character incorporates a borrower’s payment history, credit score, credit history, and relationship with prior debtors.

What are the principles of the 5 Cs of credit that banks operate on?

The main principle behind the five Cs is to gauge the risk of extending credit to a borrower. A lender needs to evaluate who they are lending money to, why the borrower is asking for money, and the likelihood of recovering loan proceeds.

Another principle of the five Cs is to determine how credit is priced. Borrowers with more favorable five Cs may get better terms, lower rates, and lower payments. Borrowers who are riskier with poorer five Cs may face unfavorable terms.

A lender also relies on the five Cs to determine whether they want to conduct business with a borrower. If a borrower’s five Cs are poor, then the lender may decline to extend credit.

Lenders use certain criteria to evaluate borrowers prior to issuing debt. The criteria often fall into several categories, which are collectively referred to as the five Cs. To ensure the best credit terms, lenders must consider their credit character, capacity to make payments, collateral on hand, capital available for up-front deposits, and conditions prevalent in the market.

USAGov. " Credit Reports and Scores ."

myFICO. “ What Is a Credit Score? ”

VantageScore. “ About VantageScore .”

Consumer Financial Protection Bureau. " What is a Debt-to-Income Ratio? "

Consumer Financial Protection Bureau. " Debt-to-Income Calculator ," Page 2.

LexisNexis Risk Solutions. “ RiskView Liens & Judgments Report .”

U.S. Department of Housing and Urban Development. “ Let FHA Loans Help You .”

U.S. Department of Veterans Affairs. " VA Home Loan Types ."

Consumer Financial Protection Bureau. " What Is Private Mortgage Insurance? "

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  1. MGT 351 Chapter 7 Flashcards

    Social Science Business MGT 351 Chapter 7 5.0 (1 review) While preparing the first draft of the business plan, the entrepreneur should not Click the card to flip 👆 take into consideration the constituencies that will ultimately read and evaluate the plan's feasibility. Click the card to flip 👆 1 / 15 Flashcards Learn Test Match Q-Chat Created by

  2. What are the 4 Cs of Credit and how does the SBA evaluate them?

    The 4 Cs of Credit refer to four key factors that lenders consider when assessing a borrower's creditworthiness. These factors are: Capacity Collateral Let's take a closer look at each of these factors and how they come into play. Character Character involves a borrower's reputation and track record.

  3. The 4 C's of Credit for Business Loans

    If you are buying a business, capacity is easier to determine, and a business that can show a positive cash flow (where income exceeds expenses) for a sustained period of time has a good chance of getting a business loan. Capital Assets of Business Capital refers to the capital assets of the business.

  4. The 5 C's of Credit: What They Are, How to Build Them

    The five C's, or characteristics, of credit — character, capacity, capital, conditions and collateral — are a framework used by many lenders to evaluate potential small-business borrowers ...

  5. CFA Level 1: Four Cs of Credit Analysis & Credit Ratios

    The 4 Cs of credit analysis include: capacity, collateral, covenants, and character. Capacity Capacity is the ability of the issuer to make debt payments according to the payment schedule. To analyze the capacity of the issuer to service its debt, the credit analysts use the following process:

  6. PDF The Four Cs and a P of Credit Worthiness

    The Four Cs and a P of Credit Worthiness guide to understand how banks make credit decisions - and the steps you can take to prepare your business ahead of time. Character: Capital: business' reputation for fiscal and personal responsibility developed through past actions.

  7. Fundamentals of Credit Analysis

    Credit analysis is a vital skill for investors and lenders. This Refresher Reading explains the fundamentals of credit analysis, such as credit risk, default probability and loss severity. It also covers credit ratings, issuer and issue risk, and the four C's of credit analysis: capacity, collateral, covenants and character. Learn how to assess the provision and volatility of yield spreads ...

  8. The four Cs of credit: What are the banks looking for?

    2022-07-11 00:00. Share. The fours Cs of credit are a common set of principles that banks and lenders consider when assessing business loan applications. The four Cs not only help the lender understand your business needs but can also help you when applying for finance. 1.

  9. 4 Cs of Credit

    The 4 Cs of Credit. The decision to extend payment terms to a new customer is based around the 4 Cs of credit granting: Character. Creditworthiness. Cash Flow. Conditions. The weight to which creditors apply each of these principles depends upon the risk tolerance of the company extending the terms. Small firms start by heavily relying upon ...

  10. Purpose

    Purpose is a mix of many things. Character, capital, capacity, and collateral - purpose isn't tied entirely to any one of the four Cs of credit worthiness. If your business is lacking in one of the Cs, it doesn't mean it has a weak purpose, and vice versa. Instead, the four categories come together to constitute purpose.

  11. The New 4Cs of Business Credit Portfolio Analytics

    The New 4Cs of Credit: The Power of Portfolio Analytics. Most every business credit professional knows about the 4Cs of Credit - how character, capacity, condition, and capital are used to evaluate the financial risk of an applicant. Today, modern finance organizations should consider adhering to four new tenets, the 4Cs of credit for portfolio analytics.

  12. What Are the Four Cs of Credit?

    What Are the Four Cs of Credit? When you want to borrow money, a potential creditor will take a close look at your background. As Bank of Labor's Senior Credit Officer, Pat Thomas, notes, "This review helps banks and other creditors determine whether or not you have the means to repay the loan."

  13. 5 Cs of Credit: What They Are, How They're Used, and ...

    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 ...

  14. The 5 Cs of Credit

    To evaluate capacity, or your ability to repay a loan, lenders look at revenue, expenses, cash flow and repayment timing in your business plan. They also look at your business and personal credit reports, as well as credit scores from credit bureaus such as Equifax, Experian and TransUnion. This is because the way a person handles personal ...

  15. Know the 4 Cs of commercial banking before applying for a business loan

    Commercial lending also has a set of four Cs: cash flow, collateral, credit, and character. Business owners seeking bank financing can benefit from understanding each of these. Cash flow. Lenders are primarily concerned with how a loan will be repaid.

  16. Chapter 7 The Business Plan: Creating and Starting the

    The business plan serves as an important tool in helping to obtain financing. Answer: True Page: 202 Difficulty: Easy 9. The four Cs of credit are computers, capital, compromise, and collateral. Answer: False Page: 202 52 Difficulty: Medium Hisrich, Entrepreneurship, Seventh Edition Chapter 7 The Business Plan: Creating and Starting the Venture 10.

  17. Exam 2-Chapter 7 Flashcards

    Study with Quizlet and memorize flashcards containing terms like The business plan is a private document and should not be read by employees and customers. -True -False, Bankers agree that most business failures are due to the entrepreneur's inability to obtain financing. -True -False, _____ and _____ are good sources of information for financial and industry operating ratios.

  18. When evaluating business plans THESE are primarily concerned with the

    Final answer: Lenders are primarily concerned with the four Cs of credit when evaluating business plans. They assess these elements to determine the risk associated with providing loans, in contrast to employees, investors, and vendors who might have other concerns. Explanation:

  19. ELE 3010 Quiz 3 (Ch. 7-8) Flashcards

    Before writing the business plan, an entrepreneur should conduct an objective self-assessment of his or her abilities which includes areas such as planning and sales skills ... When evaluating business plans _____ are primarily concerned with the four C's of credit. Distribution. The _____- element of the marketing mix involves decisions as to ...

  20. When evaluating business plans _________ are primarily concerned with

    Final answer: Lenders are primarily concerned with the four Cs of credit when evaluating business plans. These include capacity (ability to repay), collateral, capital (equity or net worth), and conditions (interest rates, amount of principal). Explanation: In the context of evaluating business plans, ' lenders

  21. Entrepreneurship Quiz 3 Flashcards

    Study with Quizlet and memorize flashcards containing terms like Which stage of marketing research is considered to be the most difficult for an entrepreneur due to lack of knowledge or experience in marketing?, The simplest approach to gathering primary information is:, When evaluating business plans _____ are primarily concerned with the four C's of credit and more.