To be successful lenders, banks must manage their risk when lending money. In addition to carefully reviewing the documentation small businesses provide when applying for a loan, lenders often make additional judgments to try and assess a borrower’s default risk (the chance that loan repayments cannot be made).
To measure different elements that contribute to default risk, lenders often consider what’s called “the five C’s of credit”: character, collateral, capacity, capital, and conditions. In addition, lenders generally make other considerations as well.
The 5 C’s of Credit
The five c’s of credit is a system lenders use to try to figure out how creditworthy a borrower is. The five c’s are described below.
- Character: Have you previously been granted credit, and did you pay it back on time and in full? Do you have any blemishes on your personal or professional credit reports?
- Collateral: Do you have items of value you’re willing to pledge to back up your promise to repay the loan?
- Capacity: Do you have enough cash flow to to make the loan payments?
- Capital: How much money are you able to put up? Are you able and willing to come up with your own money so it’s not only funds from other investors at risk?
- Conditions: How do you intend to use the money? What’s the appropriate interest rate to charge, repayment time-frame, and other details?