When banks and other financial institutions make lending decisions, they often rely on the five C's to measure the creditworthiness of an individual borrower or business entity. By measuring these five characteristics, lenders seek to limit their risk and make their loans to borrowers in the best position to pay back the money in full and on time.
Character
When it comes to a personal loan, character is a somewhat subjective term, and each banker will look at an individual's character in a slightly different way. For business loans, character often refers to the management style of the business and the experience of the management team. In either case, the borrower looks at the integrity of the would-be borrower and makes a lending decision based on that evaluation.
Capacity
Capacity in this case means the capacity of the borrower to pay the money back. To evaluate this "C" the lender looks at the borrower's lending and repayment history, as well as credit scores and other subjective measures of creditworthiness.
Capital
Capital refers to the assets the borrower has invested in the business, including equipment, cash flow and retained earnings. The lender will look at the original investment the business owner put up, as well as subsequent profits and how they were reinvested into the firm.
Conditions
Outside conditions can impact the ability of an individual or business to pay back the loan, and the lender must carefully evaluate these potential impacts. For personal loans, outside conditions like high levels of unemployment could cause the borrower to default. In business, a recession or downturn in particular industry could cause the loan to go bad.
Collateral
Collateral refers to assets the borrower uses to secure the loan. When a homeowner takes out a home equity loan, that money is secured by the property. Business people may take out loans and use the assets of the business to secure the funds.
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