Think you should be eligible for a loan? You might not be as trustworthy as you think.
It can be easy to think you’re eligible for a loan without putting yourself on the other side of the lending fence. Lenders often consider the “4 Cs” when determining whether they’re likely to get their money back from a loan.
However, it’s not always as cut and dried as it seems. Read on to learn more about each of the 4 Cs.
How lenders evaluate character
Even Mother Teresa might’ve failed a bank character test: It turns out that looking after the sick and poor isn’t necessarily a solid financial move.
When lenders analyze your character, they consider it in relation to the likelihood of you repaying a loan. They ask:
- Do you have stable living arrangements and a stable job?
- Have you taken out loans in the past and used them responsibly?
- Are you an organized person who’s in control of your finances?
- Can you prove to the lender that you’re fiscally responsible?
Among other elements of your character, lenders consider these questions both on their own and in relation to your credit history. Lenders take your financial obligations seriously and likewise look at your character for reassurance that you’ll take them seriously.
How would you judge your own character?
Put yourself in the lender’s shoes: One of the first things you’d look at before lending somebody money is how they’ve treated borrowing in the past. To learn about your financial history, a lender checks out your credit history. You can go to Equifax, TransUnion or Experian to take a look at your credit score and see a snapshot of your creditworthiness. Checking your own credit online is both secure and won’t leave a mark on your credit history.
Remember that lenders know only what you’ve included on your application and what’s in your credit report. Set aside any extenuating circumstances and sheer bad luck (if applicable), and look at yourself as a number on the page. Consider the reasons behind any negative information on your application or in your credit report to determine whether they should count against your character.
How lenders evaluate collateral
Lenders love collateral because it makes loans less risky. Collateral is an asset you put up against your loan. Cars and houses are some of the most common types of collateral, because they’re valuable and can be sold to recoup expenses if you default on your loan.
Loans requiring collateral are called secured loans, while those without are called unsecured loans. More valuable collateral typically means a lender will be more lenient in their judgment, while less valuable collateral means you might have to score higher on the other 3 Cs.
How would you judge your own collateral?
Think about the assets you’d offer as a borrower — and whether they’d be worth it to you as a lender. The first thing you’d have to consider is the type of collateral you’d use and how much it’s worth.
Many lenders know how value houses or conduct a professional property appraisal first. If you’re putting up your car as collateral, the lender looks at the current market value and ongoing depreciation to determine how much it can be sold for.
How lenders evaluate capability
A main factor to your potential loan approval is how financially capable you are to repay the loan. Sometimes this is as simple as the lender looking at your income versus your expenses to calculate if you’re able to make another payment on top of your other debt or financial obligations.
A high salary indicates to a lender that you have good capability to repay a loan. But your debt-to-income ratio provides a more complete picture of how much you can afford to borrow. Your debt-to-income ratio is simply how much your debt payments are each month divided by your monthly income.
Having more than one source of income can be a plus, because having two streams of cash flow means you’re more likely to keep up with repayments, even if something goes wrong.
How would you judge your own capability?
This is pretty easy to do: Look at your budget and see whether you can comfortably squeeze in another payment.
How lenders evaluate capital
Capital is generally considered a combination of collateral and capability. Specifically, it looks at the value of your assets outside of anything you may have listed as collateral for your loan. Someone with high amounts of capital will likely have a lot of assets that can be sold to meet repayments, while someone with low capital might find themselves out of options, which means a higher likelihood that a lender will lose money on the loan.
For personal loans, lenders might look at your personal capital as an indication of your financial security. Business lenders look at capital in relation to the total value of your business assets, whereas home lenders look at capital in relation to your property value and potential deposit.
How would you judge your own capital?
Take a look around at what you own. How much is it all worth? Would you be willing to sell your (hypothetically) prized stamp collection on eBay if you had to? Look at the total value of your assets in relation to the total value of your potential loan. If your assets greatly outweigh the loan, you can judge yourself fairly well on capital.
If you’re after a personal loan, know that you’ll find a lot of options available for different borrowers, purposes and personal circumstances — so shop around to find the best loan for you.
We discovered that credit cards and loans aren’t the only way Americans borrow money. It turns out that friends and family borrow an estimated $184 billion each year for bills, rent, medical emergencies and more.