Credit · July 17, 2020

5 Cs of Credit: What Banks Look for When Lending

While banks don't have universal rules about what makes someone creditworthy, they're guided by some general principles. These are the five Cs of credit: character, capacity, capital, conditions and collateral. Making choices that reflect these characteristics—and building the habits you need to get there—can take some of the stress out of obtaining credit.


1 Character

Character helps lenders discern your ability to repay a loan. Particularly important to character is your credit history. Your credit report will show all debts from the past 7 to 10 years. It provides insight into your ability to make on-time payments as well as your length and mix of credit.

Your credit report will also assign you a FICO score. Typically, the higher your score, the more likely you are to qualify for the types of credit you need.

How to improve

Begin by ensuring your credit report is accurate, and report any discrepancies to the bureaus.

Payment history is one of the largest components of your FICO score. One way is to pay your bills on time by setting up automatic online payments for your debts. You can also pay down existing debt or use a co-signer with good credit when applying for a loan.

2 Capacity

Capacity measures your ability to repay your debt. Here, your cash flow is paramount, along with your debt-to-income ratio.

The lender wants to know how much you owe versus how much you own. The lower your debt-to-income ratio, the more favorable a bank will look at your request for credit. Other considerations include length of time at your current job and income stability.

How to improve

First, calculate your debt-to-income ratio by dividing your total monthly debt by your gross monthly income. Assess if the number is too high to apply for additional debt. Typically, banks look for a debt-to-income ratio of less than 36% as an indicator that a borrower is responsible with credit.

Second, try to pay down your debt. Debt consolidation or refinancing can help. Also, apply for a loan when you know you can prove job and income stability. The longer you're at a job, the more favorable your chances for a loan.

3 Capital

Capital shows lenders you're serious and committed to the credit you're seeking. For individual loans, this means a down payment when applying for a loan. For a business loan, this means you've invested some of your own money into the business.

Do you have any cash on hand to be able to provide as capital? Often, the more equity you have, the more favorable your loan conditions will be.

How to improve

If you don't have savings, there are loans you can still apply for without capital. Your loan terms may not be as desirable, but if you're in good standing with the other five Cs of credit, a bank may still lend you money.

That said, stick to a budget and find ways to create an emergency fund before borrowing. If an unexpected event occurs—such as losing your job—you'll want a nest egg to continue making timely payments on your loan.

4 Collateral

Collateral provides assurance to the bank in case you're unable to pay for the loan. For example, if you secure an auto loan, the car is your collateral. If you default on your loan, the bank can repossess the car.

Lenders will look at what sort of property—bank accounts, real estate, equipment, automobiles—they'll be able to use as collateral as they offer you a loan.

How to improve

Take stock of your possessions. Do you owe debt on any of them? What's the value of your property? These items may be seen as collateral if you're unable to repay your loan.

If you don't have collateral but still need to secure a loan, you might look for a co-signer. This is a person who has collateral to back the loan. Remember, using a co-signer is a big responsibility. You now have your own—and someone else's—financial security at stake.

5 Conditions

This refers to the current economic health of the market and the industry you work in. Is the country going through an expansion or recession? Are your prospects for advancing in your professional life currently growing or shrinking? What are the current trends, and are there layoffs expected?

How to improve

This component of the five Cs of credit is the least in your control. Banks are more willing to give you credit during expansionary periods. When market conditions are favorable, this may be a good time to see what terms are available for the types of credit you're currently seeking.

In slower economic periods, banks prefer specific loans—such as home improvement loans over signature loans—which can be used for any purpose.

Build a strong financial foundation

Keep these characteristics in mind as you try to better understand your financial picture and work toward your goals. If you can show a history of responsibly using credit in a way that reflects the five Cs, you'll put yourself in a better position to obtain the financing you need to build the life you want.

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This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.