5 C’s of credit – What it is, definition and concept | 2022

The 5 C’s of credit are five elements that are evaluated of a person to determine their level of credit risk. That is, to study the client’s solvency and his ability to meet his financial obligations.

In other words, the 5 C’s of credit are five characteristics or aspects that are analyzed in a debtor or potential debtor. This, to determine how likely it is that the loan will be repaid.

Next, we will present the five Cs, focusing particularly on the case of a loan for companies or for working capital.

The first C of the 5 C’s of credit: Character

Character has to do with the level of trust a customer generates. It is related to the user’s qualities as a person and not to the business or company in question.

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The bank or financial intermediary will assess whether the individual pays their loans on time, and, in general, the reputation of the client will be studied.

This factor will be positively evaluated if the user maintains a good relationship with the banking entities.

Ability

The capacity item refers to how the user plans to meet his financial obligations, that is, the economic means with which he has to repay the loan received.

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At this point, the customer’s credit history and income stream are primarily evaluated. In this way, it seeks to determine if the user will have sufficient resources in the future to repay the acquired debt.


The capacity will be evaluated positively if the user does not have credits that exceed his payment capacity and if he has always been complied with paying his debts on time.

Capital

The capital corresponds to the resources that the debtor has invested in his company or business.

At this point, we must remember that a company is usually launched with its own and third-party funds. The own funds are the capital, while the resources of third parties are the debt acquired with agents outside the business, such as a bank.

The lender will consider positive that the debtor is not building his business solely with debt. This, since by including your own resources you will probably act more diligently in managing money.

Collateral

Collateral is any asset that can be pledged in a way that serves to compensate the creditor in the event of default.

The collaterals can be of different types, such as real estate (as in the case of mortgage loans). However, it can also be presented to a third person as a guarantee, so that this individual agrees to assume the debt in the event that the borrower defaults on his obligation.

It should be noted, on this point, that the debtor may not want to put any of his properties at risk. For this reason, you should be informed enough to acquire a loan with reasonable conditions, such as interest rates that are not so high. In this way, you will not run a great risk of losing, for example, his home.

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Conditions, the last C of the 5 C’s of credit

The conditions comprise two aspects that are evaluated. First, an internal one, about how the company or business is doing, in general. That is, if the company is capable of generating income.

Likewise, there is a second aspect which is external. This refers, for example, to the economic situation of the country or to the situation of the industry. In other words, we are talking about exogenous variables that can affect the debtor.

It should be noted that the debtor may have interference in the internal management of his business. However, you have no control over external factors and there are no actions you can take to make the assessment more or less positive.

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