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Learn the 5 most important things lenders consider when you apply for a business loan.
Bottom Line Up Front
- 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.
Time to Read
2 minutes
May 17, 2022
Are you planning to apply for a business loan? No matter where you apply, there are 5 key factors that lenders look at to score your loan application, judge your creditworthiness and set your interest rate.
What are the 5 Cs of credit?
Lenders score your loan application by these 5 Cs—Capacity, Capital, Collateral, Conditions and Character. Learn what they are so you can improve your eligibility when you present yourself to lenders.
- Capacity. To evaluate capacity, or your ability to repay a loan, lenders look at revenue, expenses, cash flow and repayment timing in your business plan. They also look at your business and personal credit reports, as well as credit scores from credit bureaus such as Equifax, Experian and TransUnion. This is because the way a person handles personal credit and their own credit cards often shows how he or she will manage business credit. Another important metric is debt-to-income ratio, or DTI, which describes your outstanding debt compared to how much you earn. The lower your DTI, the better your liquidity, and the more likely you’ll keep up with timely payments.
- Capital. To get a line of credit, you’ll need to show that you have capital—some of your own money or money from partners—that you can put toward startup or acquisition costs. Think of it as a down payment to show you’re serious and capable.
- Collateral. If you fall behind on loan payments, financial institutions want to make sure you have collateral, or another source of repayment for the loan. Your loan application should include real estate or other things that could be sold if you fall behind on debt payments.
- Conditions. Lenders want to be sure there’s a market for your business. Make sure your business plan proves that you will be successful based on economic conditions, competition, industry type and your history as a small business owner.
- Character. This includes your education history, business background and personal credit history. Include any references or other information about your financial situation. It helps if you and your staff have a good reputation in your industry.
The 5 Cs Checklist
Before you make your loan request, ask yourself these questions to make sure you’ve addressed all 5 Cs in your loan application and business plan:
- Is my business following all local, state and federal laws and regulations?
- Have I studied my competition and industry trends?
- Am I providing a needed product or service?
- Am I committed to making my business succeed?
- You can get help crafting your business plan in preparation for seeking a loan from counselors at www.SCORE.org, the Service Corps of Retired Executives.
- The U.S. Small Business Administration offers 5 steps for building business credit quickly.
- Navy Federal Credit Union offers a variety of business credit services, from real estate loans to business lines of credit.
Credit & Debt Resources
Credit Scores & Reports
Credit Scores & Reports
Credit Scores & Reports
This content is intended to provide general information and shouldn't be considered legal, tax or financial advice. It's always a good idea to consult a tax or financial advisor for specific information on how certain laws apply to your situation and about your individual financial situation.
As a seasoned financial expert with a proven track record in the field, let me delve into the intricacies of the article and shed light on the concepts involved. My extensive experience and in-depth knowledge allow me to provide valuable insights into the 5 Cs of credit and the crucial factors lenders consider when evaluating a business loan application.
The article emphasizes the 5 Cs of credit: Capacity, Capital, Collateral, Conditions, and Character. Let's break down each concept and explore the evidence provided in the article:
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Capacity:
- Capacity refers to the borrower's ability to repay the loan.
- The article outlines that lenders assess revenue, expenses, cash flow, and repayment timing in the business plan to evaluate capacity.
- Personal and business credit reports, along with credit scores from agencies like Equifax, Experian, and TransUnion, are considered.
- The debt-to-income ratio (DTI) is highlighted as a crucial metric, emphasizing the importance of maintaining a lower DTI for better liquidity and timely payments.
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Capital:
- Capital involves the financial commitment from the borrower, showcasing personal investment or contributions from partners.
- The article emphasizes the need to demonstrate capital as a down payment, indicating seriousness and capability.
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Collateral:
- Collateral acts as security for the loan, providing an alternative source of repayment if the borrower defaults.
- The article suggests including real estate or other valuable assets in the loan application as potential collateral.
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Conditions:
- Conditions refer to the external factors that may impact the success of the business.
- Lenders want assurance that there's a viable market for the business.
- The article advises proving business viability based on economic conditions, competition, industry type, and the business owner's history.
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Character:
- Character encompasses the borrower's personal and business background, education history, and credit history.
- A good reputation in the industry, along with references and additional financial information, is considered essential.
The article concludes with a checklist for potential loan applicants, urging them to address specific questions related to the 5 Cs. It emphasizes legal compliance, market analysis, commitment to success, and the importance of seeking assistance from organizations like SCORE.org for crafting a comprehensive business plan.
In summary, the 5 Cs of credit serve as a comprehensive framework for lenders to assess the creditworthiness of business loan applicants, and the article provides practical guidance for entrepreneurs to enhance their eligibility in the lending process.
