What is 5 C’s of Credit?
The 5/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 the loan, attempting to estimate the chance of default and, consequently, the risk of a financial loss for the lender. The five C’s of credit are:
- Character – Although it’s called character, the first C more specifically refers to credit history, which is a borrower’s reputation or track record for repaying debts.
- Capacity – 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.
- Capital – Lenders also consider any capital the borrower puts toward a potential investment. A large contribution by the borrower decreases the chance of default.
- Collateral – 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.
- Conditions – The conditions of the loan, such as the interest rate and amount of principal, influence the lender’s desire to finance the borrower. Conditions can refer to how a borrower intends to use the money. Lenders may consider conditions that are outside of the borrower’s control, such as the state of the economy, industry trends, or pending legislative changes.