When you apply for a loan, lending institutions consider a few factors when making the decision whether to approve or decline a loan.
The following is a breakdown of the criteria, also known as the 5 c’s:
Collateral: This is basically what secures the loan. For instance, physical property would be the collateral for a real estate loan, or a vehicle for an auto loan. There are even cases where you can borrow against your own money, which would be secured by a CD(Certificate of Deposit) or savings account.(This is an excellent way to build or repair credit). I will talk about this in more detail in a later post.
Capital: This is what would be what is used to repay the loan, such as your primary income. Investments, CD’s, or other liquid assets could be considered capital in the event of a loss of the primary source of income.
Capacity: This would be what your level of comfort is for repaying the debt. In other words, your ability to afford the loan repayment. This is where your debt to income ration comes into play. How does your monthly debt stack up against monthly income…
Character: Two words…Credit History. How has your payment performance been in regards to previous debts. Did you have late payments? Do you have any delinquent accounts? This history typically goes back 7 seven years.
Conditions: This is the final piece. What is the purpose of the loan or what will the funds be used for. Loan terms, interest, and fees are part of the conditions. The current state of the economy at the time of the loan is a condition as well.
When all of these factors are viewed as satisfactory, this is when your loan will been approved. Before applying for your next loan, underwrite yourself and answer the 5 c’s, that way when you walk into the lending institution, you can apply with confidence.