What do diamonds and credit have in common?

Most of us know the 5 Cs of diamond quality: Color, Clarity, Cut, Carat, and Certification. But there is another set of Cs that are more valuable than diamonds.

They are the 5 Cs of creditworthiness. Creditworthiness is an assessment conducted by a lender (or creditor) in order to determine the likelihood of a borrower defaulting on a loan.

Lenders will use the following 5 Cs to determine your creditworthiness:

  1. CHARACTER: The lender will look at how you handled credit. For example, were you late with payments in the past; do you jump around, changing jobs and residences every few months; how long have you been at your current job/field. They would also look at how you save. Do you have a habit of saving as opposed to spending all of your available credit?

  2. CAPACITY: Will you be able to repay the loan? This is the question that the lender would want answered. To answer this question some of the things they will look at include your payment history, the type of credit you acquired in the past, and your Debt Service Ratio. Debt Service Ratio is the percentage of your monthly income that is spent on debt repayment.

  3. CAPITAL: This is the amount of money that the borrower is willing to risk towards the purpose of the loan. For example, if you are seeking a mortgage to buy a house, your capital would be your down payment. With the borrower having capital, it means that the lender is not the only one taking on the risk of the purchase of the house. This also applies for personal loans.

  4. COLLATERAL: This is a security that the lender uses in case the borrower defaults on the loan. Some examples of collateral are:

    • For a mortgage, the property would be collateral.

    • If the borrower has investments, the lender can use that as a security for a loan of a lesser value.

    • Sometimes the lender may ask for a guarantor or co-signer for a loan – this is also a type of collateral since if the borrower is unable to pay, the guarantor becomes liable.

  5. CREDIT REPORT AND SCORE: This bears the most weight of all the Cs. By looking at your credit report and score, lenders can tell not only your likelihood to repay your loan but can see how you have dealt with other lenders in the past. They can see if you had debt that went to collections or if you had to seek legal or non-legal assistance (for example, bankruptcy; debt management assistance; etc.) to meet your obligation of repaying your creditors.

    Your credit report will also show the lender your Bankruptcy Index Score which tells them the likelihood of you filing for bankruptcy.

Like the 5 Cs of diamond quality, knowing your 5 Cs of creditworthiness can be invaluable information. Do you know where you stand with your 5 Cs. Book your free consultation with me today to find out.