THE 5CS OF CREDIT Money Management II

What We’re Doing Today Where lenders get their information What lenders look at before they extend credit: Character Capacity Capital Collateral Conditions How you can improve your chances of obtaining credit: Minimizing debt Making on-time payments

Where the 5 Cs Come From When seeking some form of credit people will have to complete an application. Credit applications can be completed online or on traditional paper forms. When combined with the information reported by a credit bureau, the information from your application will establish your credit rating. Your credit rating is the measure of a person’s ability and willingness to make credit payments on time.

Character – Will You Repay the Loan? Character: The distinctive nature of something What type of person are you? Trustworthy? Stable? Why is this important? What kinds of questions/inquires might be helpful in determining someone’s character?

Character – Will You Repay the Loan? Common Questions/Inquires to Determine Character:  References (Both personal and professional)  Criminal background check  Have you used credit before?  How long have you lived at your current address?  How long have you held your current job? Good Character will give the lender confidence that you have every intention of paying the loan back in full, in a timely manner.

Capacity – Can You Repay the Loan? Capacity – The maximum amount something can contain Your income and the debts you already have will affect your ability to pay additional debts Common Questions:  What is your job and how much is your salary?  Do you have other sources of income?  What are your current debts?

Capacity – Can You Repay the Loan? The more debt you have, in relation to your net income, the less likely a lender is to extend credit. A common ration used is the Debt Payments-to-Income Ratio This ratio is calculated as followed: Total Monthly Debt Payments (Not including housing) ÷ Monthly Net Income It is highly recommended to keep this ratio under 20%

Debt Payments-to-Income Ratio Example Stuart just received his first job offer after graduating from beauty school. His expected monthly income is $2,500. The only debt payments he has are school loan payments of $375 a month. What is his Debt Payments-to-Income Ratio? Debt Payments ÷ Monthly Net Income $375 ÷ $2,500 =.15 15%

Capital – What Are Your Assets and Net Worth? Asset – Any item of value that you own  Cash  Property  Personal possessions  Investments Capital – How much your assets exceed your liabilities (Debt!)

Capital – What Are Your Assets and Net Worth? Lenders like to know this information in case you lose your source of income. Will you be able to repay the loan through savings or by selling some of your other assets? Common Questions:  What are your assets?  What are your liabilities?

Collateral – What If You Do Not Repay the Loan? Collateral – Something pledged as a security for repayment of a loan. Creditors will look at the assets you have because they may be offered as collateral to secure the loan incase of default.

Collateral – What If You Do Not Repay the Loan? Not all lenders use collateral! They are secured loans and typically borrowers are much more careful in making on-time payments. If the loan has some form of collateral written into the agreement, the creditor has legal rights to the item pledged as collateral. Common Question:  What assets do you have that you are willing to use as collateral?

Conditions – What If Your Job Is Insecure? Conditions can refer to both big and small picture concerns. What are the general economic conditions at the time of applying?  Unemployment Rate  Recession Lenders will also look at your specific company and position.  Is the company defensive or cyclical?  Is your position in demand? How expendable are you?

Wrap-Up & Review By reviewing the information reported by a credit bureau and your application lenders will determine whether or not you qualify for a loan. This information focuses on 5 categories:  Character  Capacity  Capital  Collateral  Conditions

Wrap-Up & Review Creditors will vary in their use of the 5 Cs to reach their decision.  Some may place more importance on certain factors than others  Some may relay on a variety of rating systems  Others may simply use their own instincts and experience The two most manageable ways to improve your chances of obtaining credit are:  Minimize Debt  Make on-time Payments