Lenders use rigorous policies and analyses when determining if and how much money to lend to clients. The methods used by lenders are often summarized by categorizing lending analysis as the five Cs of credit. The five Cs of credit are character, capital, capacity, conditions and collateral. Lenders use the five Cs for specific reasons respective to each category, but all are utilized to understand the risk of default on a loan.
It is important to a lender to have significant comfort with the character of its prospective borrowers. Indicators such as credit score in conjunction with your credit report - which is primarily a detailed list of your credit history, consisting of information provided by lenders that have extended credit to you. While information may vary from one credit reporting agency to another, the credit reports include the same types of information, such as the names of lenders that have extended credit to you, types of credit you have, your payment history. In addition the lender will consider more qualitative factors such as honesty and integrity which support a case for a borrower's willingness and ability to repay a loan.
While your household income is expected to be the primary source of repayment, capital represents the savings, investments, and other assets that can help repay the loan. This can be helpful if you lose your job or experience other setbacks.
Lenders need to determine whether you can comfortably afford your payments. Your income and employment history are good indicators of your ability to repay outstanding debt. Income amount, stability, and type of income may all be considered. The ratio of your current and any new debt as compared to your before-tax income, known as debt-to-income ratio (DTI), may be evaluated.
A lender must also understand the type of loan you are applying for, broader market conditions affecting the industries, segments, and overall economy in which they operate in.
Lenders often take a lien on borrower collateral. In the event a borrower is not able to repay debt with its cash flow, a lender must rely on the quality and sale-ability of borrower collateral to repay the loan. A robust analysis of the collateral supporting a loan is an important step in granting a loan.