When you walk into your bank and apply for a loan or a mortgage. Do you ever wonder what your banker is actually thinking when they are deciding whether or not to loan you money? You may have an awesome relationship with your banker, you may have even gone to lunch or played tennis with your banker. But when it comes down to lending you money, it’s a whole other ball game.
When banks are assessing whether or not they should lend you money, there are many things they look at. There’s what’s called the 5 c’s of credit and these 5 c’s of credit determine whether or not you are credit worthy.
Here’s the break down:
Collateral
Collateral is the security the bank has if you don’t pay your debt. Credit cards are unsecured, meaning the bank has nothing to sell to get their money back if you decide you don’t want to pay your bill, or if you can’t pay. This is why the interest rates on credit cards are much higher than mortgage and car loan rates. There’s more risk, which means you pay more. If you don’t pay your credit card bill your bank will send you to collections and the collection agency will try to collect the money. If you don’t pay your mortgage or car loan. The bank will eventually just sell your car or your house to get their money back. Lower risk, means lower rate.
Character
Character is what your bank looks at to determine if you’ll actually pay them back. Banks always look at your past to determine your future. They want to know how responsible you’ve been with your current and past debts. Have you been paying your bills on time, do you pay your bills at all, do you go over your credit card limits, are you a credit seeker, meaning have you applied for every credit card under the sun. All of these factors determine your character.
Capacity
Capacity is affordability. Your bank definitely wants to know if you can afford your debt. After all, what’s the point of lending someone money if you know they can’t pay you back. That’s more like a gift, and we all know banks aren’t in the business of giving gifts. Your debt-to-income ratio is very important when determining capacity. Your bank will look at your income and all of your current debt and determine if you can handle more debt and how much more debt you can handle. Remember your banks main concern is can you afford to pay them back.
Capital
Capital is how many assets you have, such as houses, cars, cash, locked in investments and so forth. The more capital you have, the less risk the bank is taking on you. Someone who has one million dollars in investments and is applying for a $250,000 mortgage on a home that’s worth $400,000 is a great candidate for the bank, assuming the other c’s are in check. This person is less risky to the bank because they’ve accumulated a lot of investments versus someone who has $5,000 in investments. The reason why the millionaire is less risky to the bank is because if he/she was to lose their job, they would still have money to pay back the loan versus someone who only had $5,000 saved. Chances are that person would default if they didn’t find another job. This makes this peron a higher risk to the bank.
Credit
Credit is extremely important. This is where the good old FICO comes into play. Banks are looking at how much credit you have, do you make late payments, are your credit cards maxed out, do you have more credit than you can afford, have you ever declared bankruptcy, do you have credit in collections, and are you a credit seeker. (They can tell this based on your inquiries)
Does anyone remember the days when you could withdraw $5 from the ATM machine? I was in high school the last time I remember banks in Canada allowing us to withdraw a minimum of $5 from the ATM. It was great! Those were also the days when you could buy a meal for $5, so it was wonderful for days when I needed to withdraw just enough money for lunch.
