4 C’s of credit are Character, Capacity, Capital, and Collateral of borrowers upon which banks/lenders have a careful look at before lending the money.
It is common for people to apply for a loan to loan lenders for meeting some of their regular expenses. Moreover, it is preferred when someone requires a potentially large amount of money in a small time window. That is why banks or other loan providers check the four c’s of credit or credit scores, as they want to see how borrowers look upon these parameters to finalize their decision about the borrowers’ ability to repay.
However, many users are not aware of the significant factors that influence the four c’s of credit score. It revolves around different factors such as DTI (debt to income) ratio, gross monthly income, monthly payments, interest rate, payment history, mortgage, etc. to check the ability to pay back the loan.
What are the 4 C’s of Credit?
Four primary factors that loan lenders check while analyzing the loan application of borrowers are four c’s of credit. As discussed above, they are-
For example, the 4 c’s of credit when buying a home revolves around the analysis of these 4 c’s when lenders look to review a mortgage application and checking whether it qualifies or not.
Why are 4 C’s of Credit Important?
The c’s here are actually a guiding light that assists and empowers lenders and other funding companies to make the right decisions while analyzing borrowers’ capacity to repay.
Many borrowers think that only their credit score will help them achieve the loan. But it is not the case as lenders look for some additional information before issuing the amount.
There may be several factors, but everything depends on the lenders who want to see the capacity of borrowers to repay the loan by paying heed to credit scores, credit history, real estate, monthly payment, collateral, debt, income, etc.
Lenders want these four c’s in their loan disbursal system, as they simplify the process of the loan, and make sure a hassle-free processing of loans.
Let us now go deep into these four c’s of credit-
Understanding 4 C’s of Credit
The character of the borrower is determined by analyzing some points based on credit history.
Sometimes, there can be the influence of several points to get an accurate picture of the character. Moreover, the factors related to character include the current debt, current credit scores, delinquent accounts, and several others.
The punctuality in paying the credit bill is also significant in deciding good credit or bad credit. If a person often delays the deadline to pay the bill, the lenders might be reluctant on offering the loan.
Also, lesser problems related to the credit bills and other factors will be the credit score. It is recommended to have a credit score of around 750. Anything above that is always beneficial, and the person can go for large loans as well.
The next factor on the list is the borrower’s capacity to repay the loan taken from the bank.
In case a business is applying for the loan, the lender will analyze the profit margin and whether the loan will be repaid in the stipulated time. It is common to see that new businesses of startups don’t have a reliable source of income.
Therefore, the business must be able to predict the profits and support a positive outflow of profits in the long run. Also, if there were revenues collected in the past time, the business will probably do it in the future.
The capacity of a borrower is also checked by analyzing debt, monthly/yearly payment, business growth possibilities, existing loans like personal or car loans, etc. If all the lender conditions are satisfied, there are high chances of the loan getting approved.
This factor is indirectly related to the capacity of the business. Capital refers to the assets possessed by the business that has the potential to repay the loan.
In other words, the business must put forward their capital as security and sell them in extreme conditions to pay the loan. This can be anything such as structural assets, machinery, current bank balance, and other investments.
Basically, the lenders are looking for quick money generators whenever necessary. This is useful in situations where the profit is not enough to pay the installment, and these commodities will get quick cash. This acts as sources to cover risk and lenders can be sure of their money.
Finally, Collateral plays an important role in urging the lenders to trust the loan borrower.
This relates to the cash aspect of the business that the borrower could pledge before getting the loan. Along with the liquid cash, assets and other similar aspects can also be included along.
Further, borrowers will have to submit legal papers regarding the property until the loan is repaid. No doubt that Collateral is only for security purposes, but there is always the risk. Therefore, getting the loan will lead to processing some security and assure the bank.
What is Credit Score?
The credit score of a borrower is decided by their payment history.
The three credit bureaus (Equifax®, Experian®) and TransUnion®) utilize an advanced program from the Fair Isaac Corporation (FICO) for checking at borrowers’ payments history, borrower defaults and then rank them on a scale between 300 and 850.
In the score sheet, 300 is considered as the worst possible score while 850 is the best possible score.
Importance of Four C’s of Credit
There is no doubt in the fact that 4 C’s of credit have their importance in the loan business. Some of the points that prove the statement are,
- Four c’s assure the lenders regarding their money after providing the loans. In case there is something suspicious about the business, lenders can easily analyze it from the credit score and other factors.
- Almost every business has to mortgage some assets before having the loan. Hence, they have to prove their capability of repaying the loan with the help of the factors mentioned above.
- 4 C’s of Credit also determine the history of the business along with the credit score. This is quite important in the market.
- Small businesses and startups can show their capacity in the industry as they have nothing in terms of Collateral. Thus, they don’t have to depend on a single factor for getting the loan.
How 4 C’s of credit helps New Businesses or Startups?
It is observed that businesses require a lot of investment, especially in the beginning.
The 4 C’s of credit will solve the financial problems and help them to get started.
They can apply for a loan and move forward with their business. Eventually, they will start gaining revenues and can pay back the loan.
This will make them self-sufficient as the headstart is already given by the loan. Independent businesses can make the best use of financial support provided by lenders.
In the end, it is understood that 4 C’s of credit defines the ability of a business or a company in the monetary market. Not only the lenders but the competitors can also get to know more about the firm.
Here it is important to note that the combination of these 4 cs is the key to qualify for a mortgage or a business loan or any other sorts of loans. Strong income ratios, as well as a large down payment, can balance out some credit issues.
In the same way, strong credit histories can assist in having higher ratios, plus good income and credit can overcome the lesser down payments. While applying for a loan, you should talk openly and freely to your mortgage advisor, as they will favourably design your loan.
What are your thoughts about the role of 4 c’s in checking mortgage or loan qualification?