6 Min Read | Updated: February 16, 2024
Originally Published: July 1, 2022
The five Cs of credit are character, capacity, capital, collateral, and conditions. Lenders use these factors to decide whether to extend credit to an individual.
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At-A-Glance
The five Cs of credit – character, capacity, capital, collateral, and conditions – refers to a method lenders use to assess a potential borrower’s creditworthiness.
Lenders weigh these five qualitative and quantitative measures, ranging from FICO credit scores to credit history, when evaluating loan applications
While many facets of the five Cs are under an applicant’s control, some may be influenced by outside factors like the economy at large.
If you’re applying for a mortgage for the first time, thinking about getting a new credit card, or hoping to finance a family car, it may be time to learn about the five Cs of credit— a framework perhaps as fundamental to the lending world as the ABCs are to the English language.
The Five Cs of Credit Explained
The five Cs of credit refer to five factors:1
- Character.
- Capacity.
- Capital.
- Collateral.
- Conditions.
These five categories incorporate qualitative and quantitative measures, helping lenders to ascertain your personal (or business) creditworthiness and decide whether you’re a good candidate for shouldering more debt.1 While every lender has a different approach to making that determination, not all use the five C’s. The more you know about this method, the better you can understand what lenders look for, and boost your chances of landing that crucial financing when needed.
1. Character: How Lenders Evaluate Trustworthiness and Credibility
Character, in lending, refers to your credibility, reliability, and reputation.2 Character answers the question: Can you be counted on to make on-time payments to your creditors for things like credit card bills, car loans, or long-term mortgages?
A borrower’s credit history, which appears on credit reports generated by the three major credit bureaus – Experian, TransUnion, and Equifax – spells out that critical intel.2 Here’s what lenders may find when they look under the hood:
Credit scores. FICO and VantageScore, the two most common credit scoring models, glean credit information, such as whether you pay your bills on time, to create a three-digit credit score ranging from 300 to 850.3,4 The higher the credit score, the more attractive a borrower is to lenders, and the better your interest rates may be.3
Credit scores can vary depending on a lender’s priorities. For example, there are at least 16 FICO credit score versions with lenders, sometimes resulting in different scores for a credit card application than one for a mortgage or car loan.5,6
Credit history. Your past is very much alive on your credit record. For example, information about a lawsuit or judgment against you can be reported for up to seven years, and bankruptcies can appear on a report for up to 10 years.7Conversely, positive credit information – such as a history of on-time payments – is also reported. These favorable traits benefit your credit “character.”
2. Capacity: Why Lenders Care About Cash Flow
Capacity refers to an applicant’s financial bandwidth – is there enough cash flow to ensure that the loan will be repaid in full?2 To find out, lenders may scrutinize aspects like a borrower’s income, income stability, and whether an increased loan payment will be a burden on top of existing debt.2
One way to calculate capacity is to determine a potential borrower’s debt-to-income ratio (DTI), which is calculated by adding up monthly debt payments and dividing that figure by gross monthly income.8 While a higher credit score reflects positively on your character, a lower DTI signals the capacity to shoulder more debt, increasing the likelihood of loan approval or consideration. A higher DTI may indicate that the borrower can’t meet their monthly payments.2
Ideal DTI requirements may differ according to lender and borrowing purpose, but the Federal Deposit Insurance Corporation (FDIC) suggests that some lenders prefer a potential borrower to maintain a DTI ratio of 36% or less, though each lender may have a different tolerance.9
3. Capital: Down Payments Signify Commitment
Capital, in this case, is the amount of money you can put as a down payment. For mortgages, car loans, and other major purchases, applicants can increase their chances of approval by making a sizable down payment.10,11 By contributing your own capital, lenders can see that you take the investment seriously – and a large contribution can reduce the risk of default. Down payment size can also affect your borrowing costs over the life of the loan.11 For instance, the higher the down payment, the less you’ll need to borrow. This can lead to lower minimum monthly payments and less interest paid over time.
For some lending options, down payment requirements may be influenced by credit score. Government-backed FHA mortgage loans, for example, require qualified first-time and return buyers with a FICO score of at least 580 to make a down payment of at least 3.5%, while those with FICO scores of 500–579 need to put down 10%.12,13
4. Collateral: Your Pledge to Commitment
Collateral is when you pledge the very asset that you are attempting to finance. Even if you have no intention of defaulting on a loan, your lender may need additional assurance that you won’t be a credit risk. That’s where collateral comes in. Collateral lets the lender knows that they can repossess the asset to get their money back, if necessary.14
Lenders tend to view collateral-backed loans, also known as secured loans, as less risky than unsecured loans, which require no collateral.14 Secured loans may offer lower interest rates and better financing terms than unsecured loans, and they are often easier to get for individuals with thin or poor credit history.14,15
In addition to the conditions of your loan, the conditions examine outside factors that come into play when lenders are looking at your credit.2 While your personal finances take center stage in a lender’s evaluation of a credit application, they may consider the loan interest rate, amount of principal, and how the money will be used.16 They may also evaluate conditions that the borrower has no influence over, such as the state of the economy, since any widescale changes or trends can figure into loan repayment.17
Why Do the Five Cs of Credit Matter?
The five Cs of credit allow lenders to more accurately measure how great a credit risk a potential borrower might pose, such as how likely it is that they’ll default on that loan, mortgage, or credit card.
Financial indicators, such as credit reports, credit scores, income statements, and loan terms, can all signal whether an applicant is creditworthy. Lenders may go about analyzing personal or business applications in different ways, but a borrower’s creditworthiness typically boils down to character, capacity, capital, collateral, and conditions.
The Takeaway
The five Cs of credit is the yardstick some lenders use to measure a potential borrower’s creditworthiness. By gauging each of the Cs, lenders can better determine whether an applicant is a credit risk. Credit history, cash flow, debt-to-income ratio, length of employment, and even the current economy are some of the qualitative and quantitative measures that may be considered before a mortgage, credit card, or auto loan is approved.
1 “Frequently Asked Questions,” Farm Credit Administration
2 “Obtaining a Loan - The C's of Credit,” PennState Extension
3 “What is a credit score?,” Consumer Financial Protection Bureau
4 “Your Credit Score,” MyCreditUnion.gov
5 “FICO® Scores Versions,” MyFICO
6 “What Are the FICO® Score Versions?,” Experian
7“How Long Does It Take for Information to Come Off Your Credit Reports?,” Experian
8 “What is a debt-to-income ratio?,” Consumer Financial Protection Bureau
9“Thinking About Buying Your First House?,” FDIC
10 “Consumer Financial Education: Housing,” DFPI
11 “Determine your down payment,” Consumer Financial Protection Bureau
12 “FHA loans,” Consumer Financial Protection Bureau
13 “FHA Single Family Origination Trends,” HUD
14 “Personal Loans: Secured vs. Unsecured,” MyCreditUnion.gov
15 “Using Credit,” Consumer.gov
16 “Learn the 5 Cs of Credit,” MyMoney.Vermont.gov
17 “Bank lending during recessions - statistics & facts,” Statista
Randi Gollin is a freelance writer and editor who’s covered topics including food trends, shopping, and cyber issues for digital publications and tech and media brands.
All Credit Intelcontent is written by freelance authors and commissioned and paid for by American Express.
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