Borrowing Basics: Credit Decisions

Borrowing Basics: How Credit Decisions are Made

Today’s column is the fifth in a series of articles providing up-to-date tips and reports which will help a family prepare a reasonable, affordable financial plan with a goal of achieving financial freedom.

The Four Cs of Credit Decision Making: When you apply for credit, the lender will review the “Four Cs” to decide whether you are a good credit risk, or in other words, whether you are likely to pay back the loan. The “Four Cs” are capacity, capital, character, and collateral.

Capacity refers to your present and future ability to meet your payments.

Capital refers to the value of your assets and net worth.

Character refers to how you have paid your bills or debts in the past.

Collateral refers to property or assets offered to secure the loan.

Generally, in order to determine your capacity, a lender will be interested in knowing that you have held the same job or same type of job for at least a year. When you ask for credit, the lender is going to want to know how much money you make each month and what your monthly expenses are. A bank or credit union will compare the amount you owe and your other monthly expenses with your monthly income. This is called a debt-to-income ratio. It helps determine how much money you can afford to borrow.

In evaluating your capital, a lender will ask how much money you have in your checking and savings accounts, if you own a home, if you have investments or other assets (for example, a car). Lenders want to determine the value of your assets, which are things you own that have financial value. Lenders will also compare the difference between the value of your assets and the amount of debt you have, which is defined as your net worth. A positive net worth demonstrates your ability to manage your money.

In order to assess whether you have paid your bills or debts in the past, which is the character aspect of the “Four Cs”, a lender will want to know if you had credit in the past. If you have a good credit history of repaying your other loans, you will have an easier time getting your loan request approved. If you have never had a credit account, you may have difficulty getting approved for a loan.

Having a good credit history shows a lender you can borrow money responsibly. In some cases, lenders may let you prove this without a credit history. They might ask for proof that you pay your rent and utility and phone bills on time or that you make regular deposits to a savings account. Other examples of alternative (nontraditional) ways to show a creditor that you are a good credit risk may include: insurance premium payments, payments of medical gills, payments for school tuition, childcare payments, payments of personal loans (documented by a written loan agreement and canceled checks). Some lenders will consider nontraditional credit, others will not.

A lender will ask if you have ever: filed for bankruptcy, had any outstanding judgments, had property repossessed or foreclosed upon, made late payments. If you answer yes to any of these questions, you will likely have more difficulty getting approved for a loan. However, in your discussions with a lender you will be able to explain what happened. Depending on your circumstances, a lender might be willing to approve your loan request.

Financial institutions will use credit reports to obtain character information. If you need guidance and support in building or rebuilding your credit, there are opportunities available to you. Neighborhood Home Solutions offers free services which include Financial Fitness classes and one-on-one credit counseling.

For more information, please visit our office at 1600 MLK Street S., St. Petersburg, or visit us on the web at Call us: 727-821-6897.

NHS is a 501(c) 3 non-profit HUD-certified housing counseling organization. All services are provided free of charge. Partners include the U. S. Department of Housing and Urban Development (HUD), HomeFree USA, Florida Housing Finance Corporation, Florida Hardest-Hit Fund, Pinellas County Community Development and the City of St. Petersburg. The Federal Deposit Insurance Corporation’s Money Smart was a source for this article.

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