Understanding the Underwriting Process: The 5 Cs of Credit (2024)

What is underwriting and what does it have to do with loan approval? We dive in to the 5 C's of Credit and how they may affect your approval and loan terms.

The 5 C's of Credit:

  1. Character
  2. Conditions
  3. Capital
  4. Capacity
  5. Collateral

The Underwriting Process of a Loan Application

Once you have submitted everything for a loan application, the information and documents are sent to a credit analyst for underwriting, or credit analysis, before an approval decision can be made. But what do the loan analysts look at?

One of the first things all lenders learn and use to make loan decisions are the “Five C's of Credit": Character, Conditions, Capital, Capacity, and Collateral.These are the criteria your prospective lender uses to determine whether to make you a loan (and on what terms).

Character (Credit History)

Lenders need to know that you are trustworthy to pay your debts. This is perhaps the most difficult of the Five C’s to quantify, but probably the most important. Looking at Credit History is the best way for a lender to see the future. If you are a repeat customer, the lender will consider how you have paid your past loans with them. A credit report pulled from one of the three credit bureaus is the most frequently used tool to measure how you have paid other lenders.

Repayment with other lenders is the primary factor that goes into generating your credit score. But the report also shows other important factors to consider such as maxed out credit cards, and the number and type of accounts you have open.

If there are any blemishes on your credit report – late payments, collections, judgments, tax liens, etc. – be ready to discuss with your loan officer at your first meeting. If there is a solid reason for an issue on the credit report, your lender will take that into consideration.

Conditions

Your lender will consider the conditions of the industry – the stability and sustainability of the land market in the area you are buying. Are current trends in land prices going up or down? What are current market values in the area you are purchasing for similar properties? Is the property you are wanting to purchase in line with current market value? What is your income source and does the stability of that payment source correspond to the trend of the land market?

Asking these questions allows your lender to help you make sure that your purchase is a wise investment for your future. You do not want to risk a dramatic change in the market that might put you in financial bind.

Capital (Cash Reserves and Liquidity)

Before approving a loan your lender must consider your current financial state. That is best done by looking at your balance sheet. The balance sheet is a “snapshot” of your financial position and outlines your assets (everything you OWN) and your liabilities (everything you OWE). When a lender is reviewing your balance sheet, they are assessing your ability to “weather the storm.” Things may not always go as planned, and your loan officer wants to be sure there are enoughcash reservesandliquidity(assets easily converted to cash – ie. Stocks and bonds) to pay your debts.

The loan analyst will confirm your assets by verifying your cash, savings and investments accounts, and verify ownership of real estate you already own.

They will also confirm your liabilities by reviewing the credit report, register of deeds on real estate, etc. There are times when analysts have a question and request additional verification. Do not worry – this does not mean there is a problem! The quicker you can provide what they need, the quicker they can move through the underwriting process.

In the end, they want to see that the total value of your assets is greater than what you owe. The difference in the two is known as Equity (or Net Worth). The more debt you owe (loans, open accounts, etc.) compared to your assets, the harder it will be for you to withstand additional debt. If most of your assets are paid for, you’ll be in a better position to take on an additional loan.

Capacity (Cash Flow)

Capacity is your repayment ability. Can you make the payments on the land loan you are requesting? To verify this, the loan analyst looks at your income sources, which determines your capacity to service

all

your financial obligations.Do you have adequate income to pay for living expenses, other mortgage or term debt payments, vehicles and taxes, and still have capacity for taking on the additional debt you are requesting?

The lender will look at twothings:

  1. Primary source of repayment.For most people, this is salaried income. The analyst will verify the reported amount and stability of your income. They will most likely need some historical information from which to build a trend, such as past tax returns or W-2s. It is important to note that for a real estate loan, it is not necessarily required that you have held a job for a certain amount of time, as you often encounter with a home mortgage. The primary consideration is that your past earnings indicate stable future earnings.
  2. Secondary source of repayment.How else will you make loan payments if the primary income source goes away? This could be a spouse’s income, rental or investment income. This is where the balance sheet ties in to the ability to repay the loan. The analyst may even consider (in a worst-case scenario) if you have assets that could be sold to repay loan debt.

Your lender does want to make sure that you can pay them back, they are also looking out for you. You have a friend in a lender who looks out for you by not allowing you to take on more debt that your income can manage.

Collateral

Lenders secure a land loan with collateral. In most real estate loans, the land itself is used for the collateral. In some cases a borrower will pledge another asset such land already owned.

Many borrowers think that Collateral is the most important “C” of the five. However, collateral is what the lender would have to depend on to repay the loan in the event that you default on your loan (which we hope never happens!), so it only becomes important if something bad occurs.

AgSouth has various LTV (loan to value) requirements which your loan officer will discuss.The maximum regulatory LTV for a real estate loan is 85%, but may be lower. LTV requirements are dependent on the type of real estate collateral being pledged and the strength of the borrower.

For example, a real estate loan with an approved 80% LTV means that if the property purchase (and appraised value) is $100,000, then the loan amount will cannot exceed $80,000. The additional $20,000 must be paid for by the borrower.

An official appraisal will be ordered following the loan approval to ensure that the property appraises and can meet the loan LTV requirements.

Recommendation for Approval

Once all the components of underwriting have been evaluated, the analyst will provide a recommendation for approval. Ultimately the intent of your lender evaluating the “5 C's of Credit” in the underwriting process is an effort to make sure that the loan decision is wise for you and sound for the lender.

Questions?

We hope this information is helpful in helping you understand how lenders do credit analysis. If you're looking to purchase land, farms or homes in South Carolina or Georgia and have questions about the loan application processone of our loan officers would me more than happy to help.

Find an AgSouth Branch

near you!

Not in South Carolina or Georgia?Find your Farm Credit Association.

Understanding the Underwriting Process: The 5 Cs of Credit (2024)

FAQs

Understanding the Underwriting Process: The 5 Cs of Credit? ›

The Underwriting Process of a Loan Application

What is the underwriting process of credit? ›

Underwriting is the process by which the lender decides whether an applicant is creditworthy and should receive a loan. An effective underwriting and loan approval process is a key predecessor to favorable portfolio quality, and a main task of the function is to avoid as many undue risks as possible.

What are the 5 C's of credit which lenders take into account when deciding whether or not they should make a loan to an applicant? ›

Character, capacity, capital, collateral and conditions are the 5 C's of credit. Lenders may look at the 5 C's when considering credit applications. Understanding the 5 C's could help you boost your creditworthiness, making it easier to qualify for the credit you apply for.

Why do lenders use the five C's? ›

Lenders use the 5 Cs of credit analysis to assess the level of risk associated with lending to a particular business. By evaluating a borrower's character, capacity, capital, collateral, and conditions, lenders can determine the likelihood of the borrower repaying the loan on time and in full.

What is the underwriting strategy for credit cards? ›

Credit card companies determine your credit limit through a process called underwriting, which uses mathematical formulas to assess your credit quality. Each company has their own proprietary way of underwriting to decide who to approve, at what rate, and at which credit line limit.

What is the 5 C's of credit? ›

Called the five Cs of credit, they include capacity, capital, conditions, character, and collateral. There is no regulatory standard that requires the use of the five Cs of credit, but the majority of lenders review most of this information prior to allowing a borrower to take on debt.

What are the 3 C's of underwriting? ›

The 3 C's—Capacity, Character, and Collateral—are key factors assessed by underwriters to gauge a borrower's creditworthiness and risk level. These elements provide a comprehensive view of the applicant's ability and willingness to meet financial obligations.

What are the 5 Cs of underwriting? ›

The Underwriting Process of a Loan Application

One of the first things all lenders learn and use to make loan decisions are the “Five C's of Credit": Character, Conditions, Capital, Capacity, and Collateral. These are the criteria your prospective lender uses to determine whether to make you a loan (and on what terms).

What are the 5 Cs of credit and what does each C refer to? ›

Most lenders use the five Cs—character, capacity, capital, collateral, and conditions—when analyzing individual or business credit applications.

What are the 5 Cs of credit and describe what each one means? ›

When you apply for a business loan, consider the 5 Cs that lenders look for: Capacity, Capital, Collateral, Conditions and Character. The most important is capacity, which is your ability to repay the loan.

What habit lowers your credit score? ›

Making late payments, even a single day late, can significantly affect your credit. This becomes especially true if you make a habit of paying late. Some lenders or credit card companies will charge you a fee for being a single day late and could cut you off from making further purchases on the account.

What does a lender look at before granting credit? ›

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.

What is the main difference between FICO credit score and credit score? ›

Is "credit score" the same as "FICO® score"? Basically, "credit score" and "FICO® score" are all referring to the same thing. A FICO® score is a type of credit scoring model. While different reporting agencies may weigh factors slightly differently, they are all essentially measuring the same thing.

What are the 7 C's of underwriting? ›

In the mortgage industry, we commonly learn about the 4 C's of mortgage underwriting: Credit, Capacity, Collateral, and Capital. However, I believe that there are three additional C's that are essential: Common Sense, Communication, and Collaboration.

What are the credit underwriting standards? ›

Key Takeaways. Underwriting standards are guidelines set by banks and lending institutions for determining whether a borrower is worthy of credit (i.e. a loan). Underwriting standards help set how much debt should be issued, terms, and interest rates. These standards help protect banks against excessive risk and losses ...

How can I improve my underwriting process? ›

How To Improve Underwriting Performance
  1. Establish Underwriting Quality Control. ...
  2. Create Standard Procedures. ...
  3. Assess Underwriter Workflow Challenges. ...
  4. Understand How Check-ins Can Improve Underwriting. ...
  5. Modernize Your Underwriting Audit Procedures. ...
  6. Explore Your Underwriting Results.
Jan 17, 2023

What does it mean to underwrite credit? ›

Credit underwriting is an important aspect of the loan process that determines an individual's or business's creditworthiness. The underwriting procedure evaluates your financial condition, repayment capacity, and credit risk whether you're looking for a personal loan, a mortgage, or a commercial line of credit.

What happens during the underwriting process? ›

When trying to determine whether you have the means to pay off the loan, the underwriter will review your employment, income, debt and assets. They'll look at your savings, checking, 401k and IRA accounts, tax returns and other records of income, as well as your debt-to-income ratio.

How long does credit underwriting take? ›

How long does the underwriting process typically take? Underwriting can take a few days to a few weeks before you'll be cleared to close.

References

Top Articles
Latest Posts
Recommended Articles
Article information

Author: Allyn Kozey

Last Updated:

Views: 6307

Rating: 4.2 / 5 (43 voted)

Reviews: 90% of readers found this page helpful

Author information

Name: Allyn Kozey

Birthday: 1993-12-21

Address: Suite 454 40343 Larson Union, Port Melia, TX 16164

Phone: +2456904400762

Job: Investor Administrator

Hobby: Sketching, Puzzles, Pet, Mountaineering, Skydiving, Dowsing, Sports

Introduction: My name is Allyn Kozey, I am a outstanding, colorful, adventurous, encouraging, zealous, tender, helpful person who loves writing and wants to share my knowledge and understanding with you.