To most Canadians, buying a property is a daunting task in itself. But what about securing a mortgage? What factors are taken into consideration by lenders and underwriters that can make or break the loan? Obviously, credit is a major decider in the equation, but what exactly goes into deciding credit worthiness? What most Canadians aren’t aware of is that credit is not just a score or an ability to make payments on time. Credit is actually composed of a few different categories known as the five C's of credit.
The 5 C's of credit consists of: Credit, Capacity, Capital, Character & Collateral.
1. Credit shows the lender a snapshot of what the borrower’s repayment history has been over a period of time. This is the only way a lender can predict the borrower’s propensity to make future payments. The credit score (also called credit history, credit report, credit rating) is the primary measurement factor.
2. Capacity is the ability to repay loans. This is arguably the most critical of the Five C's of credit. Lenders look at debt service ratios (Total Debt Service and Gross Debt Service) as well as payment history in order to assess a borrower’s capacity or ability to repay a loan.
3. Capital is the amount of money that borrowers have invested in a property. Otherwise known as a down payment, lenders want to see how invested you are in a property before making a decision. Loan to value is a measurement used to determine the amount of capital required as down payment, in addition to rate and terms of the mortgage.
4. Character can be described as a borrower’s general trustworthiness to repay loans. Factors such as length of employment, in addition to the borrower’s propensity to save and utilize credit responsibly all help to establish character.
5. Collateral can be thought of as additional security provided to the lender. The subject property itself and its value, location and characteristics can be thought of as security, but collateral can also include outside parties who will guarantee the loan. These parties are often referred to as covenant partners.
The goal is to get a yes to your deal with a lender. The Five C's of credit outlined above determine a borrower’s ability and willingness to make payments. Understanding what a lender is looking for allows you to set yourself up to put your best foot forward.