When lenders are considering to lend money to borrowers, there are several factors they look at before making their determinations.
The basic system of analysis a lender will typically use ‘initially’, prior in entering into an extended credit analysis, is an initial screening of the borrower.
That screening is called the “5 C’s of credit.” The 5 C’s of credit that lenders look at are collateral, capacity, character, capital, and conditions. When evaluating a potential borrower, this screening system will give a lender a clear picture of what it would most likely be like to lend money to this entity.
When looking at a potential borrower, collateral can give the lender a little more peace of mind if they are unsure about whether or not to lend the borrower money. When the potential borrower owns collateral assets, such as property, ships, factories or other tangible assets, if they were to default on their loan, they have collateral that the lender can potentially repossess, limiting the amount of risk associated with the loan.
When a lender looks at capacity, they are weighing the amount of funds the entity makes as revenue and income versus the amount of debts they have to pay every month.
If paying the loan back would put them at a disadvantage financially, the lender may hesitate on approving the loan because chances are, it won’t be paid on time. It is essential for the potential borrowers to demonstrate in advance their capacity to make debt service payments and ability to repay back the loan.
Credit reports and due diligence are the best way to learn about a borrower’s past credit patterns and business character. Viewing a borrower’s credit history can show the lender how punctual, successful and committed they are to paying back their debts on time. If there are multiple examples of a borrower defaulting on a loan or failing to pay back a debt, the lender may be hesitant to lend them money.
If a potential borrower is requesting financing and at the same time the borrower also participates with a large portion from their own funds, lenders feel more comfortable and the chances are that it is more likely for a loan to get approval status. Reasons are if the borrower is already putting down a considerable amount as equity, they are participating on the risk factor which demonstrates confidence from the borrower’s side. This is quite common in commercial lending when business loans provide a financing level smaller than the actual value of the asset. For instance, the borrower provides financing of up to 70% of the asset’s actual value. This is the LTV (Loan to Value) level. Then, if the remaining 30% of the funds are provided by the borrower, this would make the financing most likely to reach approval status.
Applying for financing for your business can sometimes seem a little challenging, but achievable if you take the proper steps and make the necessary planning ahead. Lenders first observe if the borrowers match the financing criteria and if the conditions of the loan will be honored by the borrowers. Conditions specify on what will be agreed between the lender and borrower, such as the loan amount, the term, the interest rate and other enforceable conditions. Potential business borrowers are required to meet the conditions of the loan agreement. That’s why potential borrowers must meet at the initial screening phase all of the 5 C’s of Credit before conditions get the necessary approvals for funding.