For this month, we will be continuing to take a look at the five Cs of credit. To refresh your memories, the five Cs include credit, capacity (ability to make the payments), capital (down payment), character (length of employment, savings history and other factors that supplement credit history) and collateral (assets owned in addition to down payment). In previous columns, we took a look at credit, capacity, capital and character.
The final one we will look at is collateral. Collateral is basically looking at a person’s net worth. It is seeing what kind of assets a person has acquired, and determining whether that helps or hurts the application. As discussed in the last column in this series, some of these can get a little subjective. Things like your credit score, down payment amount, debt service ratios and others are all objective, measurable requirements. When we talk about collateral, there often isn’t a set criterion that the lender will look for. It is more a way for the lender to look at the big picture to see if everything fits together and to get a better sense of who they are lending money to. It generally isn’t the basis that an approval or decline is made on, but it can be the deciding factor when everything else is borderline.
One example would be a young couple buying their first home. Maybe they have just finished university, have zero net worth and are using a gifted down payment from a parent. While this may not seem like the strongest application, the lender will often read between the lines. The fact that they have just finished a university education with no debt might prove their character enough for a lender’s comfort. A contrasting example might be someone who has been in a decent paying job for quite some time that is using a gifted down payment. The lender might question their financial management skills considering they have been making good money and not saving any of it. Again, the credit and debt service ratios would be the foundation of their decision, but collateral can tip the scales when things are close.
Well that sums up our review of the five Cs of credit. Now we have looked at credit, capacity, capital, character and collateral. While this stuff can be a little dry, I hope it has helped to clarify what lenders are looking for when issuing credit, and why they ask for certain things. If you have any specific questions, feel free to call or email any time.