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- About Home Equity Loans In Texas And How Can One Obtain It - November 27, 2023
The 5 C's of Credit
Forget trigonometry, in this post, we will learn what they should teach everyone in school, the 5 C’s of credit. We will understand credit and what exactly it means from a bank’s perspective.
A lot of people don’t realize that there are 5 C’s of credit. The 5 C’s of Credit is simple.
They are Capacity, Capital, Collateral, Credit, and last but not least Character. And we are going to break those down to get a better understanding.
1st C Of Credit: Capacity
Capacity is precisely what it sounds like. It simply means what the capacity of your debt load is, and it looks at two major things.
The first thing is the gross debt service ratio (GDS), which is all the associated costs with owning the house vs. your gross income.
The second one is the total debt service ratio (TDS), which factors in the GDS so that all the housing costs we are considering, Plus any other monthly obligations like a credit line, credit card payments, loan payments, etc.
That is Capacity, the 1st of the 5 C’s of credit you need to know.
2nd C Of Credit: Capital
Capital is just your capital investment, which means how much money you are bringing into the investment.
In case of a regular purchase and you are financing your first home, if you have good credit and if it is affordable, you might need as little as 5% down based on your capacity.
If you are buying a rental property you would need a more down payment. If you are missing some other C’s, you may need more capital in the investment.
The easiest way to understand the capital is how much skin you are putting in the game in the form of a down payment.
3rd C Of Credit: Collateral
In the literal sense means, how many other assets the borrower has that the bank can potentially leverage and secure security against the borrowed money.
So if you are borrowing money, and you have other forms of collateral like property or land that the bank can take additional security on so that they feel more confident in lending you more money.
So collateral is what else you bring to the table that might add additional security.
4th C Of Credit: Credit
Credit is one of the critical C’s. This is where your bank looks at your credit history, and they look more importantly into repayment history.
A common misconception people have with some of their revolving debts like credit lines and credit cards is that it doesn’t matter if they are two or three days late because they end up paying substantially more than their minimum payment.
It is great that you are paying more than your minimum payment.
However, when a lender is looking at your credit, they want to see that you had an obligation on a specific due date and that you met it. So this is where your credit becomes vital for a lender.
5th C of Credit: Character
When we talk about Character, the lender is not looking at your personal character. They are looking at things like your job history. Do they change the job a lot, are they hopping from job to job in short intervals.
There are always valid explanations for a job change. However, if you have a history of hopping from job to job, that is when a character could come into question.
If the lender is considering giving you money over a 5-year term, they would like to see a stable income.
Another aspect of character would be your address history. If you are unable to hold down a steady address.
Lenders would not only like to see you have a long term job, and you can commit to employment, but you are also able to set some roots.
Conclusion
If you are planning to borrow money, now is the time for you to check your 5 C’s of credit to determine how you can improve your credit assessment.
Be sure to be upfront with your lender if one or more of your 5 C’s of credit needs improvement. By providing high-quality complete information, you already prove a level of responsibility and transparency.
