Five Cs Of Credit
The 5 Cs of credit are location, location, location.
Wait, no, that’s not right. Those are the three rules of real estate. Let’s try that again.
The 5 Cs of credit are character, capacity, capital, collateral, and conditions, and they are what guide lenders on whether or not they should loan us money. Let’s see about those Cs…
“Character” is less about our personal charisma and more about our financial reputation. Do we pay our bills? Do we pay them on time? Are we now or have we previously been bankrupt? Are there any tax liens against us? Basically, if someone were to judge us solely on our financial history, would we look like a good person?
“Capacity” looks at how much we make and how much we owe, and tries to figure out if we can afford to pay back the loan we’re trying to get.
“Capital” is how much of our own money we can fork over toward whatever we’re trying to finance. For example, if we’re trying to buy a house, we’re more likely to get a loan if we can put down a 20% down payment versus only putting down a 10% down payment.
“Collateral” is stuff that we own that we can put up against a loan. Like...let’s say we’re trying to buy a vacation house in the Florida Keys. In order to secure the home loan, we put our house in Denver up for collateral. This means that, if we default on the Keys loan, the bank can get what we owe them from the value of our Colorado house.
And last but not least, certain “conditions” might come into play. Are we taking out a loan to add a garage onto our house, or are we just borrowing money for vague and unspecific purposes? Are we trying to grow a business that impeding regulations might shut down completely within the next year? Is the economy in general about to tank, making it less likely we’ll be able to repay the loan?
On the one hand, this can seem like a lot of stuff to keep track of. But on the other, we guess it’s nice to know that lenders are trying to get a big-picture view of our financial situation before they support—or crush—our financial dreams.