This week we’ll wrap up the Five Cs of Credit!
The third C is Capital. Capital is the amount a borrower is willing to put towards a potential investment. With credit, this is generally referring to a down payment. The larger the capital contribution, the less likely a borrower is to default. Many lenders, especially in the housing market, have minimum down payments for their collateralized loans, which are loans to purchase large assets like homes and cars. A larger down payment may help with your eligibility and in some cases may even qualify you for lower interest rates. There are also personal benefits to larger down payments; a larger down payment means lower future monthly payments, less interest over the life of the loan, and you’ll be less likely to go under water on your loan, meaning you owe more on the loan than the value of the asset, which is especially risky when it comes to car loans with small down payments.
The fourth C is Collateral. Collateral represent what the lender gets if the borrower defaults. This can be a number of financial assets, but very often it’s the asset your purchasing itself. If you don’t pay for car loan, the lender can repossess your car, if you don’t pay your mortgage for several months, they can start the foreclosure process. Loans with collateral are generally considered to be less risky, since the lender has a more straightforward recourse if you default. This is why you’re credit card and personal loan interest rates are likely higher than your auto loans or mortgages.
The fifth and final C is Conditions. Generally, this is referring to market conditions – the state of the economy, trends in that industry, and other external factors beyond your control. For instance, from about 2009 to 2016, interest rates were at record lows. A prospective borrower with identical creditworthiness may have dealt with interest rates multiple percentage points higher in 2007 than just five years later in 2012.