Five Cs Of Credit
The 5 Cs of credit are location, location, location.
Wait, no, that’s not right. Those are the three rules of real estate. Let’s try that again.
The 5 Cs of credit are character, capacity, capital, collateral, and conditions, and they are what guide lenders on whether or not they should loan us money. Let’s see about those Cs…
“Character” is less about our personal charisma and more about our financial reputation. Do we pay our bills? Do we pay them on time? Are we now or have we previously been bankrupt? Are there any tax liens against us? Basically, if someone were to judge us solely on our financial history, would we look like a good person?
“Capacity” looks at how much we make and how much we owe, and tries to figure out if we can afford to pay back the loan we’re trying to get.
“Capital” is how much of our own money we can fork over toward whatever we’re trying to finance. For example, if we’re trying to buy a house, we’re more likely to get a loan if we can put down a 20% down payment versus only putting down a 10% down payment.
“Collateral” is stuff that we own that we can put up against a loan. Like...let’s say we’re trying to buy a vacation house in the Florida Keys. In order to secure the home loan, we put our house in Denver up for collateral. This means that, if we default on the Keys loan, the bank can get what we owe them from the value of our Colorado house.
And last but not least, certain “conditions” might come into play. Are we taking out a loan to add a garage onto our house, or are we just borrowing money for vague and unspecific purposes? Are we trying to grow a business that impeding regulations might shut down completely within the next year? Is the economy in general about to tank, making it less likely we’ll be able to repay the loan?
On the one hand, this can seem like a lot of stuff to keep track of. But on the other, we guess it’s nice to know that lenders are trying to get a big-picture view of our financial situation before they support—or crush—our financial dreams.
Related or Semi-related Video
Finance: What are credit ratings, and ho...59 Views
finance a la shmoop what our credit ratings and how are they interpreted?
well maybe you've heard your parents groan about all of their accumulated
debt or at least you did in high school and you know how it's sinking them. your [kid asks for dinner]
mom put the new fridge and dishwasher on her Amex and now it's all maxed out. your
dad meanwhile invested in a new set of golf clubs and put his flight to Myrtle
Beach on his visa, and now well your dad might have a nice tan and maybe he's
shaved a few strokes off his game, but you and your sister are eating baked
beans out of the can and taking time to 30-second showers to cut down on you
know gas expenses, so credits evil right? you should only pay for something if
you've got the cash right now in your pocket to pay for it right? well no not
right it's true making purchases on credit and be abused and often is but
building credit ie showing the rest of the world that you can borrow money and
then pay off your purchases responsibly whether you're an individual or a
corporation is absolutely essential in making your way through this vast [computer game labyrinth pictured]
complicated world of ours and establishing your own credit rating. so
what really is a credit rating ?well it's a determination of your ability to pay
your debts fully and in a timely manner. all right well there are three major
credit rating agencies who specialize in making these types of evaluations for
the big boys ie large public corporations who borrow money all the
time. the agencies well they're the ones with catchy names like Moody's Standard
& Poor's and Fitch. note that these three are typically used to determine the
reliability of businesses to pay off their debts.
don't confuse credit rating agencies with credit reporting agencies, of which
the major players are Equifax Experian and TransUnion. those guys publish credit
reports assigning credit scores to individuals. so they determine whether
you're able to get that Prius you've had your eye on or whether you can get [orange Prius pictured]
the keys to a nice new condo or whether you can finally upgrade from your
antique typewriter to Mac. but credit ratings indicate whether
someone might want to trust this or that company to make good on their debts.
check out this table which gives you the rundown of Moody's and SNP ratings right
there. don't worry about Fitch for now they're low man on the totem pole .all
right for Moody's anything rated be a three or better is considered investment
grade. for S&P well it's anything triple b-minus or higher. so both agencies would [credit rating chart pictured]
recommend investing in a company's debt at the top of their class, but for any
failing below this line well they've kind of slapped a junk ish bond label on
it. in other words you know and take your chances. the better the grade the better
a company is done in keeping their books checking their boxes crossing their T's
and dotting your I's and likely it means that they're a low risk. and so
they get cheap interest rate. though the odds are paying back their debts are
high when the risk is low and they're encouraged borrow more money until
they're not a good credit risk. well the ones at the bottom of the barrel are
probably sending weekly emails soliciting funds to you know help [sympathetic woman sits behind a computer]
Nigerian Prince's in distress. so those are credit ratings if you find yourself
in a position to care about them well now you know what they mean and how to
interpret them. as for your personal credit score well just make regular
payments don't spend well beyond your means and refrain from ordering one of
everything off Amazon and you should be just fine. [woman shops from computer]
Up Next
What is a line of credit? A line of credit is kind of like a loan. A bank gives a borrower a line of credit, which basically says they can borrow ...
How do credit card companies work? Credit card companies are, in a way, lenders. They give consumers a rectangular piece of plastic that allows the...