Home | Blog | Obtaining Financing For CRE Projects Part II: Understanding The Five C’s Of Credit
June 21, 2019
The five C’s of credit established a thorough system of checks and balances that weighs each component to gauge the potential for borrower default as well as the overall possible risk of loss for the financers. Understanding the five C’s of credit can help you determine your current credit status as well as determine your eligibility for a commercial real estate loan.
Understanding How The Five C’s Impact Your Ability To Borrow Capital
Today’s lenders have learned from their predecessors’ (as well as their their own) mistakes. As a result, most banks and larger loan institutions have implemented what’s known as the “five C’s of credit,” which includes:
- Character
- Capacity
- Capital
- Collateral
- Conditions
Character
Financial institutions want to lend to investors that have consistently repaid debt. This component of the five C’s is essentially the borrower’s credit history, which determines their pattern for meeting previous or current debt obligations. Beyond demonstrating the ability to pay back a loan, banks may also include analysis on:
- Current standing in the market
- Capability for growth
- Experienced and knowledgeable in the industry
- Showing a sustainable business model
During the character evaluation phase of the credit assessment, a bank may ask for items such as personal financial statements, personal and business credit reports, the performance of deposit accounts, bank statements, and owner resumes.
Capacity
Also known as cash flow, capacity determines a borrower’s ability to repay debt. In essence, capacity focuses on whether the investment can generate enough cash flow to repay overall debt. Capacity can sometimes be called the Primary Source of Repayment. To determine positive cash flow, a borrower must demonstrate a debt service coverage ratio of 1.2x or greater to ensure there’s enough wiggle room in the repayment plan to account for anything unexpected that may impact cash flow. Lenders may ask for historical, interim, and projected financials, tax returns, and rent rolls for leased properties to determine a broad scope of capacity.
Collateral
Collateral serves as a safety net to cover unforeseen circ*mstances that diminish a borrower’s capacity (aka cash flow). It’s important to note that while collateral is a safeguard and protective measure, it is not meant to be a principal repayment source. For lenders, establishing a specific monetary value for collateral is essential to prove that an organization has assets of a quantifiable amount that can cover the loan in the event it’s needed as a secondary source of repayment. To gauge collateral potential, lending institutions will typically assess the valuation of the commercial real estate property, equipment and assets, depreciation, and a statement on marketable security accounts.
Capital
Capital establishes a company’s ability to sustain an economic downturn as well as gauges a borrower’s commitment to the success of the property’s enterprise. Low capital standing can mean that the investor isn’t wisely managing existing corporate interests. Lending companies typically follow the “Cash is King” mentality, generally expecting owners to contribute 20-30% of the total investment value to secure financing. Retained earnings and capital raises by private investors may be considered to gain a full understanding of total capital scope.
Conditions
Beyond a borrower’s specific financial history, it’s also essential for banks and other financial institutes to also evaluate a wide range of current external economic conditions as well. During times of economic downturn or turbulence, it may be tougher for commercial property investors to secure the financing they need, regardless of the other four C’s of credit.
Southpace Properties collaborates with commercial real estate owners to help them locate and secure their next corporate investment. Contact us today to hear more.
FAQs
The five Cs of credit are character, capacity, capital, collateral, and conditions.
What are the 5 Cs of commercial credit? ›
The five Cs of credit are character, capacity, capital, collateral, and conditions.
What are the 5 Cs of lending application? ›
The five C's, or characteristics, of credit — character, capacity, capital, conditions and collateral — are a framework used by many lenders to evaluate potential small-business borrowers.
Which of the 5 Cs of credit deals with the financial ability to repay a loan with present income? ›
When you apply for a business loan, consider the 5 Cs that lenders look for: Capacity, Capital, Collateral, Conditions and Character. The most important is capacity, which is your ability to repay the loan.
Which one of the 5c's refers to your ability to meet the loan payments? ›
Capacity refers to your ability to repay the loan. The prospective lender will want to know exactly how you intend to repay the loan. The cash flow from the business, the timing of the repayment, and the probability of successful repayment of the loan will be considered.
What does five Cs of credit mean in finance? ›
The lender will typically follow what is called the Five Cs of Credit: Character, Capacity, Capital, Collateral and Conditions. Examining each of these things helps the lender determine the level of risk associated with providing the borrower with the requested funds.
What role does the five Cs of credit play in the commercial lending process? ›
At its core, this financial practice relies on evaluating creditworthiness through the "5 Cs": character, capacity, capital, collateral, and conditions. These factors play a pivotal role in determining loan risk and terms, serving as a vital guide for both borrowers and lenders in commercial lending.
What are the six basic Cs of lending? ›
The 6 'C's — character, capacity, capital, collateral, conditions and credit score — are widely regarded as the most effective strategy currently available for assisting lenders in determining which financing opportunity offers the most potential benefits.
Which of the 5 Cs of credit refers to an asset pledged against a loan to give the lender more security that the loan will be repaid? ›
The value of your collateral will be evaluated, and any existing debt secured by that collateral will be subtracted from the value. The remaining equity will play a factor in the lending decision. Keep in mind, with a secured loan, the assets you pledge as collateral are at risk if you don't repay the loan as agreed.
Which is not one of the 5 Cs of credit? ›
Candor is not part of the 5cs' of credit.
Profitability is affected by a variety of factors – not all of which are strictly financial. I refer to these as the “Five Ps” of business success: Product, Pricing, People, Process, and Planning.
Which of the 5 Cs of credit help determine the ability to repay a loan based upon incoming and outgoing cash flow? ›
Capacity or cash flow measures the business's ability to repay a loan. Our lenders will compare current income with recurring debts and evaluate the business's debt-to-income ratio.
Which of the five Cs of credit analysis is the money the entrepreneur has personally invested in the business? ›
Capital is the money you have personally invested in the business and is an indication of how much you have at risk should the business fail.
Which is the most important within the 5 Cs of credit? ›
Capacity
Capacity refers to your ability to repay loans. Lenders can check your capacity by looking at how much debt you have and comparing it to how much income you earn. This is known as your debt-to-income (DTI) ratio.
What is the key element of the 5C's? ›
5C Analysis is a marketing framework to analyze the environment in which a company operates. It can provide insight into the key drivers of success, as well as the risk exposure to various environmental factors. The 5Cs are Company, Collaborators, Customers, Competitors, and Context.
What are commercial credits? ›
Commercial credit is a pre-approved amount of money issued by a bank to a company that can be accessed by the borrowing company at any time to help meet various financial obligations. Commercial credit is commonly used to fund common day-to-day operations and is often paid back once funds become available.
What do the 5 Cs of credit stand for quizlet? ›
what are the five C's of credit? character, capacity, capital, collateral, and conditions. Character definition.
What are the 7Cs of credit? ›
The 7Cs credit appraisal model: character, capacity, collateral, contribution, control, condition and common sense has elements that comprehensively cover the entire areas that affect risk assessment and credit evaluation.
What are the six major Cs of credit? ›
The 6 'C's — character, capacity, capital, collateral, conditions and credit score — are widely regarded as the most effective strategy currently available for assisting lenders in determining which financing opportunity offers the most potential benefits.
