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Do the 5Cs of Credit Still Matter?

Though all lenders are not created equal, they do have one thing in common; they use the 5Cs of Credit as benchmarks when reviewing a loan application. The 5Cs are:

Character is often reflected in your credit score. Because everyone with 20% or more ownership in a business is considered when reviewing a loan request it is important that all owners have good credit; the higher the better. Anything below 700 will be cause for concern. Low credit scores are often an automatic rejection by traditional lending institutions (banks, credit unions, etc.); in the private lending market they are not an automatic rejection but will need to have viable explanations. Your experience and education also come into play here.

Capacity is probably the most important of the 5Cs as it relates to how they will get repaid. The lender will look at your cash flow, timely payment history and the probable successful repayment of the loan. Past performance is a good indicator of future performance.

Capital shows how much you have invested in the business and therefore how much you personally have at risk. The greater your risk, the greater comfort the lender has that you will protect that investment. We often have people who have invested little to nothing in the business, have low credit scores and expect the lender to finance 100% of their business. If you have brought nothing to the table, there is nothing to keep you from walking away.

Collateral represents the additional resources that gives the lender security that they will recoup any loss. Collateral may be personal assets you own (home, car, etc.) or assets of the business (equipment). If your collateral is insufficient (the discounted value does not exceed the amount of the loan) they will also ask for a guarantor; someone who has a strong Personal Financial Statement (PFS) who will guarantee that if you default on the loan they will repay it on your behalf. Lenders do not want your collateral as they then have to dispose of it to recoup their money; but they have to have some level of assurance that they will be made whole in the event you default.

Conditions are reflective of how the finances will be used (also called Use of Proceeds). Funds may be used for working capital, expansion, construction, etc. Some lenders have an appetite for one type of use (expansion for example) but don't like to deal with working capital. It is important to know what the "sweet spot" of the lender is so that you don't waste time asking to finance something the lender doesn't like to support. Remember, each time your credit score is pulled it lowers it so if you are shopping your loan to multiple lenders it can actually hurt you in the long run. Make sure you know who likes your type of project before submitting an application. The lender also looks at the market and the overall economy

The more you know how you fare in these five categories before you request a loan, the more success you will have in securing one. Remember, traditional banks are not the only source for financing; don't be discouraged if a bank rejects your request; just do your homework or better yet, solicit the help of an expert who can help you package yourself and your request in a more favorable light. Even if there are dings in your credit Also, there are a lot of good government programs; but they too look at the 5Cs of credit. As with all things government, the paperwork involved ban be daunting but it can be worth it in the end.

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About the Author

Karen Hosey, First Capital Solutions, Inc
950 Eagles Landing Parkway
Stockbridge, GA 30281

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