What Are the Four C's of Loan Approval

My lender kept talking about the Four C’s of Lending. What does this mean and how does it affect my loan? Lenders don’t want to foreclose on a property. As Lender’s begin to consider a file for approval, they are looking at four areas of risk. Those four areas are Character, Capacity, Collateral, and Capital. So what do these Four C’s mean?

Character- What is the person’s willingness or desire to repay the loan. In today’s world, we look at a credit report to determine how the borrower has paid their accounts in the past, to predict how they will pay their debts in the future. Late payments, collections, repossessions, or even a bankruptcy make a lender have serious doubts about the borrowers intent to repay a new loan.

Capacity- Can the borrower afford to make the payments on the loan they desire? Employment history, income, debt to income ratios are all part of a borrower’s capacity to repay the loan. If someone wants a loan with monthly payments of $2,400 but only makes $2,300 a month they cannot afford the payment. Obviously, lender’s are not looking at whether you make at least more than the monthly payment you are requesting, but consider ratios that are in line with standards of living. Typically, a persons debt should not exceed 40%-45% of their total income. This allows them extra money for food, clothing, etc.

Collateral- What is the lender securing the debt against? The collateral, in our case a home, is the lender’s protection of the money they lend. In today’s market the value of a home has become a more integral part of the picture, since we have recently seen that housing prices can fall. East Tennessee has been fairly lucky with regard to home values, but states such as California, Arizona, and Florida have seen significant drops in home values. Home values become even more important if borrowers lose their jobs, the economy slows down, and foreclosures rise.

Capital- Cash is King. Lenders have always looked at cash reserves and down payments as compensating factors in loan approval. The more excess cash that a borrower has, the better ability for them to ride out the storm of a job lose or drop in income.

Now you know what lenders are referring to when they talk about the Four C’s of loan approval. If you know someone that is considering purchasing a home, send this blog to them. The more informed the borrower, the better their financing options become.

richard.swan@migonline.com

This blog is for informational purposes and is the opinion of the writer. In financial matters always solicit professional advice and legal counsel if necessary.