Home | Blog | Obtaining Financing For CRE Projects Part II: Understanding The Five C’s Of Credit
June 21, 2019
The five C’s of credit established a thorough system of checks and balances that weighs each component to gauge the potential for borrower default as well as the overall possible risk of loss for the financers. Understanding the five C’s of credit can help you determine your current credit status as well as determine your eligibility for a commercial real estate loan.
Understanding How The Five C’s Impact Your Ability To Borrow Capital
Today’s lenders have learned from their predecessors’ (as well as their their own) mistakes. As a result, most banks and larger loan institutions have implemented what’s known as the “five C’s of credit,” which includes:
- Character
- Capacity
- Capital
- Collateral
- Conditions
Character
Financial institutions want to lend to investors that have consistently repaid debt. This component of the five C’s is essentially the borrower’s credit history, which determines their pattern for meeting previous or current debt obligations. Beyond demonstrating the ability to pay back a loan, banks may also include analysis on:
- Current standing in the market
- Capability for growth
- Experienced and knowledgeable in the industry
- Showing a sustainable business model
During the character evaluation phase of the credit assessment, a bank may ask for items such as personal financial statements, personal and business credit reports, the performance of deposit accounts, bank statements, and owner resumes.
Capacity
Also known as cash flow, capacity determines a borrower’s ability to repay debt. In essence, capacity focuses on whether the investment can generate enough cash flow to repay overall debt. Capacity can sometimes be called the Primary Source of Repayment. To determine positive cash flow, a borrower must demonstrate a debt service coverage ratio of 1.2x or greater to ensure there’s enough wiggle room in the repayment plan to account for anything unexpected that may impact cash flow. Lenders may ask for historical, interim, and projected financials, tax returns, and rent rolls for leased properties to determine a broad scope of capacity.
Collateral
Collateral serves as a safety net to cover unforeseen circ*mstances that diminish a borrower’s capacity (aka cash flow). It’s important to note that while collateral is a safeguard and protective measure, it is not meant to be a principal repayment source. For lenders, establishing a specific monetary value for collateral is essential to prove that an organization has assets of a quantifiable amount that can cover the loan in the event it’s needed as a secondary source of repayment. To gauge collateral potential, lending institutions will typically assess the valuation of the commercial real estate property, equipment and assets, depreciation, and a statement on marketable security accounts.
Capital
Capital establishes a company’s ability to sustain an economic downturn as well as gauges a borrower’s commitment to the success of the property’s enterprise. Low capital standing can mean that the investor isn’t wisely managing existing corporate interests. Lending companies typically follow the “Cash is King” mentality, generally expecting owners to contribute 20-30% of the total investment value to secure financing. Retained earnings and capital raises by private investors may be considered to gain a full understanding of total capital scope.
Conditions
Beyond a borrower’s specific financial history, it’s also essential for banks and other financial institutes to also evaluate a wide range of current external economic conditions as well. During times of economic downturn or turbulence, it may be tougher for commercial property investors to secure the financing they need, regardless of the other four C’s of credit.
Southpace Properties collaborates with commercial real estate owners to help them locate and secure their next corporate investment. Contact us today to hear more.
FAQs
The five Cs of credit are important because lenders use these factors to determine whether to approve you for a financial product. Lenders also use these five Cs—character, capacity, capital, collateral, and conditions—to set your loan rates and loan terms.
What are the 5 Cs of commercial lending? ›
The five Cs of credit are important because lenders use these factors to determine whether to approve you for a financial product. Lenders also use these five Cs—character, capacity, capital, collateral, and conditions—to set your loan rates and loan terms.
What are the 5 Cs of credit approval? ›
The lender will typically follow what is called the Five Cs of Credit: Character, Capacity, Capital, Collateral and Conditions. Examining each of these things helps the lender determine the level of risk associated with providing the borrower with the requested funds.
Which one of the 5c's refers to your ability to meet the loan payments? ›
Capacity refers to your ability to repay the loan. The prospective lender will want to know exactly how you intend to repay the loan. The cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan will be considered.
Which of the 5 Cs of credit deals with the financial ability to repay a loan with present income? ›
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 are the 5 Cs of credit standards? ›
Called the five Cs of credit, they include capacity, capital, conditions, character, and collateral.
What is the 5C principle of lending? ›
The 5 C's of credit are character, capacity, capital, collateral and conditions. When you apply for a loan, mortgage or credit card, the lender will want to know you can pay back the money as agreed. Lenders will look at your creditworthiness, or how you've managed debt and whether you can take on more.
What are the six major Cs of credit? ›
The 6 'C's — character, capacity, capital, collateral, conditions and credit score — are widely regarded as the most effective strategy currently available for assisting lenders in determining which financing opportunity offers the most potential benefits.
What are the 7cs of credit? ›
Condition – The purpose and details of your loan. Capacity – How you plan of to repay the loan. Collateral – A form of security that guarantees repayment. Character – A look at your credit history, demonstrated responsibility and the integrity of your actions.
What are the c4 Cs of credit? ›
Character, capital, capacity, and collateral – purpose isn't tied entirely to any one of the four Cs of credit worthiness. If your business is lacking in one of the Cs, it doesn't mean it has a weak purpose, and vice versa.
Breakthrough tech entrepreneur Chinedu Echerou is urging budding businesses to observe what he calls the 'Five Cs of Entrepreneurship' - credibility, clarity, conviction, capital and concentration in execution.
What are the five Cs that banks consider when loaning money to a business? ›
Lenders just want assurance that potential business borrowers are a safe and smart place to “invest” their loan dollars. One way to look at this is by becoming familiar with the “Five C's of Credit” (character, capacity, capital, conditions, and collateral.)
Which of the five Cs of credit analysis is the money the entrepreneur has personally invested in the business? ›
Capital is the money you have personally invested in the business and is an indication of how much you have at risk should the business fail.
What are the 5 Cs of commercial credit? ›
The five C's, or characteristics, of credit — character, capacity, capital, conditions and collateral — are a framework used by many lenders to evaluate potential small-business borrowers.
How do lenders and investors use the 5 Cs of credit when evaluating a request for financing? ›
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 not one of the 5 Cs of credit? ›
Candor is not part of the 5cs' of credit.
Candor does not indicate whether or not the borrower is likely to or able to repay the amount borrowed.
What are the 5 Cs used for in business? ›
What is the 5C Analysis? 5C Analysis is a marketing framework to analyze the environment in which a company operates. It can provide insight into the key drivers of success, as well as the risk exposure to various environmental factors. The 5Cs are Company, Collaborators, Customers, Competitors, and Context.
What are the 5Cs when it comes to farm lending? ›
The five Cs of credit is a common technique lenders use to evaluate your farm loan application and include character, capital, capacity, collateral, and conditions.
What are the six basic Cs of lending? ›
The 6 'C's — character, capacity, capital, collateral, conditions and credit score — are widely regarded as the most effective strategy currently available for assisting lenders in determining which financing opportunity offers the most potential benefits.
