The 5 Cs of getting approved for credit
Once upon a time, if you wanted to get a bank loan, you'd put on your Sunday best and clear your schedule for an hour to meet with a loan officer. Today, technology has made it possible to apply for credit pretty much anywhere, anytime.
But it's smart to prepare for a future where credit becomes harder to get. And even if that doesn't happen anytime soon, having a better understanding of what a lender looks for can help you put your best foot forward when applying to borrow money.
Traditionally, lenders will consider what are known as "The Five Cs of Credit." Knowing the Five Cs in advance could help you secure a lower interest rate, qualify to borrow more money, and have a better sense of how much to borrow. And remember, just because you're offered a certain amount of credit, that doesn't mean you have to take it all.
What is your capacity to service debt? This looks at your income and calculates how much of it is needed to carry your debts. You'll likely have come across the Gross Debt Service Ratio (GDS ratio) and Total Debt Service Ratio (TDS ratio) when researching buying a home.
If you calculate your net worth, by adding up what you own and then subtracting what you owe, a bigger number will give lenders more confidence that if things go awry, you'll have access to other resources you could sell to pay your debt.
If you asked a lender for $20,000 to pay for a trip around the world, and you lost your job right after the trip, it may be more difficult for the lender to recoup the money they lent to you. But if you asked for $20,000 to help buy a $25,000 car, that car will be attached to that loan as collateral. It's a pledge of value that could be redeemed to cover all or a partial amount of the money being loaned if you fail to make your payments. That reduces the risk for the lender, and makes them more likely to give you a loan.
How have you used and managed (or mismanaged) credit before? If you have a history of always making your payments on time and have demonstrated responsibility with managing different types of credit, this is more attractive. If you've gotten in over your head before, this is obviously less attractive, since it indicates you might repeat that behaviour.
Lenders consider your past behaviour to evaluate your ability to meet your future responsibilities. How long have you been in your current job or industry? How long have you lived at your current address? Answers to these types of questions are an indicator to the lender of your stability and reliability.