5Cs Of Credit: Do You Stack Up As A Borrower?

August 24, 2015
Ali Batten

There are many reasons that a bank will decide to either approve or decline a home loan application. No matter what though, lenders base their assessment on your worth as a borrower using the so-called ‘5 Cs of Credit’. Applicants who can clear this assessment will have a much better chance of getting approved.
The 5 Cs stand for character, capital, capacity, collateral and conditions but what does that mean for you and your ability to qualify for a home loan?

Character amounts to your willingness to pay back the mortgage. Simply put, lenders consider your personal and business reputation.
The first of the 5 Cs of credit largely involves a look at your credit file. The lender will check to see if you’ve got any blemishes or bad credit red flags such as defaults or bankruptcy in your credit history.
Lenders will also consider your stability as a borrower, specifically, how long you’ve been in your current job, how often you’ve changed addresses in the past couple of years and if you’ve been paying your bills regularly or not.

The second of the 5 Cs is capital and it represents the amount of wealth that you possess and includes any assets or valuables that make up your total net worth. In short, it’s the value of your assets minus your liabilities.
You can estimate your capital by deducting how much you owe from how much you own.
For example, your savings, the value of your car, any real estate you already own and investments, such as shares, minus any personal loans, HECS/HELP or credit card debts.
In the event of a financial setback like losing your job, banks like to see that you have a safety-cushion for repaying your home loan.
By looking at capital, banks also get an idea of your ability and willingness to save and accumulate assets. Unless you’re fairly young, a lack of accumulated assets raises a red flag to the bank that you’re probably not that good with your money.

Continuing the 5 Cs of credit, lenders use capacity to get an idea of your ability and your means of repaying the loan.
Essentially, banks work this out with a debt-to-income or ‘servicing’ ratio based on how much you earn compared to your level of debt. Think of it as your incomings versus your outgoings.
Your incomings refer to your income, rental income or anything else you earn from investments you have. Your outgoings refer to things like your rent, bills and debts such as loans and credit cards.

Collateral is the property that’s used to secure the loan. It can be a building, including your home, or equipment owned by your business or by you, personally. Typically, it should be equal to or greater than the size of the home loan.
If you’re unable to make your mortgage payments as agreed, the bank has the right to seize your property to repay the debt although other avenues are explored before going down this path, including reducing or freezing your home loan repayments for period of time.
If they do sell your property, you will hold onto any capital gains from the sale.
If you can’t provide collateral or security in the form of property, a number of lenders offer guarantor loans.
They work the same as a standard home loan except your loan is secured by your parents’ home. Best of all, you can borrow the full amount of your property plus the costs of completing the purchase (stamp duty and other legal fees).
That means you don’t need a deposit and you can avoid the cost of Lenders Mortgage Insurance (LMI), a one off fee normally charged when borrowing more than 80% of the purchase price.

The last of the 5 Cs of credit is known as conditions and it refers to the financial conditions that exist at the time that you submit your application, specifically, your interest rate, principal amount and general market conditions.
It basically refers to any outside events or circumstances that may affect your financial situation and ability to make home loan repayments.
It hasn’t been long since the RBA cash rate dropped to an all-time low of 2.00%. This has increased the borrowing capacity of home buyers. Also, due to the recent policy changes in Australia, most banks and lenders have reduced the amount investors can borrow.
Because of these conditions, home buyers can borrow more whereas many lenders allow investors to borrow only up to 80% of the property value at the moment.

Contact either Owun, Suzanne, Costa or Anthony on 02 9517 1818 or newtown1@mortgagechoice.com.au to discuss your options. Or, if you feel like dropping in at our office, we are located at Suite 106, Flourmill Studios, 3 Gladstone Street, Newtown 2042. Be sure to share our blog on Facebook and Twitter and let others join the conversation!

Posted in: Home loans

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