Have you ever wondered how a bank or a lender evaluates you when you apply for a loan or a mortgage?
Having been a lender, I want to share with you some “inside information” and help you improve your chances of getting approved for a loan, if and when you need one.
Most lenders use what they call the 5 C’s to determine if they are willing to lend you money or not. The 5 C’s stand for: Character, Capacity, Credit, Collateral and Capital
Character: A lender will first evaluate your character. We’re not talking about whether you are a funny, charming or smart person (wouldn’t it be nice to get approved for a loan based on that criteria?!) What the lender cares about is your FINANCIAL character and your intentions to repay the loan in a dependable way. He will determine your level of integrity, trustworthiness and honesty. This will be reflected in the way you handled previous loans but also your current relationship with money. The lender wants to see if you are overspending, living beyond your means or if you respect your financial limits and know where you stand.
Capacity: The basic question the lender will try to answer here is “Are you able to repay the loan?” This will of course depend on your current income, how long you have been in your job (job stability), your accumulated savings and the future outlook. If you have just started a new position and you are still on probation, and you have no cash savings, the lender will have a harder time approving you than if you have been in the same company for years and you have a “cushion” to support you if you lose your job.
Credit: This is basically where the lender will analyse your credit report and see how much debt you already have outstanding, how much total credit you have access to (line of credits, loans, credit cards, store cards,…), if you pay your bills on time, if you ever declared bankruptcy, where and when you have applied for loans in the past, where you have worked, and tons of other information present in your credit report! I strongly recommend that you order a copy of your credit report and see all the information the lender sees about you, but also to correct anything that might be wrongly stated.
In Canada, 2 organizations can provide you with your credit history report: Equifax and TransUnion. Check out the following link for the steps required to get your report:
Collateral: The lender will check if you have any assets that can be used as collateral to secure the loan. For example, your house will be used as collateral for your mortgage or your car might be collateralized against your car loan. If you default on the loan, the lender has the legal right to seize the asset and sell it to repay the loan. Sometimes the lender could ask for cash collateral if you are applying for a credit card and you are new in the country and don’t have any credit history yet.
Capital: This is basically a measure of your net worth and your general financial situation. It is tightly related to your financial character. It is a strong indication of your personal financial management skills. The lender will try to see how financially responsible are you and how much you are currently worth in dollar terms. A lack of accumulated worth could be a danger signal unless you are fairly young and just starting your career.
So here you go! Now you know with which set of eyes the lender sees you.
If you are ever refused a loan, don’t be shy to ask why. The only way to improve your chances for next time is by improving the “C” where you didn’t score a lot.