It’s helpful to understand how potential borrowers are assessed, so you can boost your chances of getting that all-important approval.
Lenders use the ‘5 C’s of credit’ which evaluate differing qualities or elements that are likely to determine your ability to repay their loan. They are:
Let’s check them out in more detail.
It sounds old-fashioned, but character in a credit sense refers to your dependability and trustworthiness. It’s important to a lender because they need confidence you’ll repay their loan.
Here’s what they’ll look at to determine character:
- Work experience (to confirm consistent income)
- Past dealings with lenders
- Credit history
Lenders will examine your credit report and score to gauge your credit history. They'll also consider how long you've been in business if you’re self-employed. The longer you work for one company, the better, as it indicates income stability.
So what can you do if your ‘character’ could use some work?
1. Improve your credit score
Bad credit can kill a loan acceptance. The good news is it’s free to find out your credit score, and easy to improve if it’s not what it should be.
Improving your credit score before applying for a loan will only improve your chances of getting the loan you want.
2. Understand your credit report
It’s also important to understand your credit report and be prepared to explain anything negative that might appear on it. Some lenders will be more favourable towards your application if you help them understand your situation.
Correct any errors on your credit report that may impact how lenders perceive you.
Capacity is your ability to repay the full amount of the loan according to the terms of the agreement.
This is the reason lenders request bank statements and proof of income, so they can assess your level of debt, your track record of timely payments (utilities for example), and the level of cash surplus and savings you hold in your accounts.
The less debt you have, the more confidence a lender will have in your ability to repay the loan and the more appealing you are to them. Paying off as much debt as you can will increase your capacity, boosting the amount of money available for lending.
Capital is the amount of money you have up front to put into the loan, such as a deposit.
A large deposit signifies commitment to the loan and an additional incentive not to default on it.
The size of your deposit can also affect your loan terms and interest rate. Generally speaking, larger deposits result in better rates and terms. With a home loan, a deposit of 20% or more should help you avoid the need for additional mortgage insurance or fees.
Collateral is an asset (or multiple assets) that a lender accepts as security for a loan in case of default. Your property will be the collateral for a home loan.
Think about what else you could offer up to boost your collateral. Do you have any other real estate you could offer as security?
Failure to make loan repayments for 120 days means a lender can start legal action, which could end with the forced sale of the property.
The terms of the loan (such as interest rate and principal) can affect the decision to lend.
These terms, along with the economic climate are known as conditions.
Conditions might also refer to how the money will be used by the borrower. A home loan or car loan for instance have specific purposes rather than a personal loan which could be used for anything.
Be clear on what you can offer, or clarify for lenders in order to meet their 5 C’s of credit to give yourself the best opportunity for an approved loan.