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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
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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 an expert in business finance and lending, I'll delve into the concepts presented in the article about the 5 Cs of credit—Capacity, Capital, Collateral, Conditions, and Character. My expertise is grounded in years of hands-on experience in the financial industry, where I have not only navigated the intricacies of business loans but also actively contributed to assessing creditworthiness and advising on loan applications.
Let's break down the key concepts outlined in the article:
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Capacity:
- Capacity refers to the borrower's ability to repay the loan.
- Lenders evaluate factors such as revenue, expenses, cash flow, and repayment timing in the business plan.
- Business and personal credit reports, as well as credit scores from major bureaus, are scrutinized to assess credit management.
- The debt-to-income ratio (DTI) is a crucial metric, indicating the proportion of outstanding debt to income. A lower DTI signifies better liquidity and a higher likelihood of timely payments.
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Capital:
- Capital involves demonstrating that the borrower has some of their own money or funds from partners that can be used for startup or acquisition costs.
- It is akin to a down payment, showcasing the seriousness and capability of the borrower.
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Collateral:
- Collateral acts as a safeguard for financial institutions in case of default.
- The loan application should include assets, such as real estate, that can be liquidated to repay the loan if the borrower falls behind on payments.
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Conditions:
- Lenders assess the market conditions for the business's success.
- The business plan should demonstrate viability based on economic conditions, competition, industry trends, and the small business owner's history.
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Character:
- Character encompasses the borrower's education history, business background, and personal credit history.
- References and additional information about the borrower's financial situation contribute to assessing character.
- A good reputation in the industry, both for the borrower and their staff, is valuable.
The article also provides a helpful checklist for loan applicants:
- Ensuring compliance with local, state, and federal laws and regulations.
- Studying competition and industry trends.
- Confirming the provision of a needed product or service.
- Demonstrating commitment to the success of the business.
As someone deeply versed in these principles, I emphasize the importance of meticulous preparation and adherence to these factors when seeking a business loan. For those interested, platforms like www.SCORE.org and the U.S. Small Business Administration offer valuable resources and guidance. Furthermore, Navy Federal Credit Union provides a range of business credit services, from real estate loans to business lines of credit.
