Back to School – The 5 Cs of Credit

In the spirit of the back-to-school season, we thought we would do a quick overview of credit basics – also known as the 5 Cs of Credit. The 5 Cs of Credit is a term used to describe the pillars of input that go into determining if a lender will lend you the money. They are Capacity, Capital, Collateral, Credit and Character.

Capacity

This component looks at your “capacity” or ability to make the payments on the mortgage. Effectively, the lender will look at your debt-to-income ratio: Will you be able to make the monthly payment given your income and other fixed expenses you have? You can improve your capacity by increasing your income (wages) or in certain cases by decreasing your monthly debt obligations. So don’t go buying a new car with huge monthly payments if you are looking to apply for a mortgage.

Capital

This is the amount of money that the applicant is putting towards the down payment. More importantly, the bank looks at where the down payment is coming from. In most cases, the down payment cannot be borrowed, but can come from own and gifted sources. While a bigger down payment is better, in the long run it may be favourable for you to purchase your property with a smaller down payment vs. spending years and years to save for a big down payment.

Collateral

Collateral is the asset that can back or act as the security for the loan. For mortgages, the collateral is the property. If the borrower defaults on the loan, the lender can repossess the property. Lenders want to make sure the collateral (the property) is worth what the borrower says it is (or what it was purchased for) and that it can be sold easily if the lender must repossess the property.

Credit

Credit is the present state of your credit history, most often reflected in your credit score. In other words, your current habits in meeting your debt obligations. If you are paying your debt on time, if you are not getting too close to, or exceeding credit limits, if you’re not applying for inferior credit products, etc. – your credit will reflect a higher score.

Character

Character is borrower’s credit reputation over a longer period of time. It looks at whether you are sufficiently trustworthy to meet your obligations. You may have a good credit score at the time of the application, but your past history may show differently. The lender will try to determine how likely the borrower is to make their payments, based on how good they were at other repayments in the past. When you apply for your mortgage, you give us consent to pull your credit score. We will review it and if there are any issues, we can discuss how you can improve it.

Photo by Tierra Mallorca on Unsplash