The six C’s of credit
If you’re applying for a personal or business loan, it’s good to know the criteria that lenders look for, which is based upon a variety of qualities. Banks and lenders use these “Six C’s of Credit” to assess your loan application. If you’re about to apply for a loan – or you know someone who is - keep reading:
Historically, the way you handle your personal credit is a good indication of how you handle your business credit, especially if you own a small business. And if you have a start-up business, this is especially important to a bank. A good rule of thumb is to request a copy of your credit report and fix any discrepancies before applying for a loan so there are no surprises. You can request your free credit report and check your credit score (a.k.a. your FICO score) using any one of these websites:
On Annual Credit Report website, you can obtain one free copy of your credit report from all three credit reporting agencies each year. Or, you can contact the three credit reporting agencies, Equifax, TransUnion, and Experian, separately to get your free credit report annually. Credit Karma will give you your credit score for free and suggest ways to help you improve your credit score, among other offers and services. Many people ask, “What is a good credit score?” While banks and other lending institutions all have their own guidelines, in general, a good score is 700 or better. If you know there is something on your credit report that might be considered derogatory and there is a very good explanation for it, tell the bank up front and they may accept your explanation. Banks don’t like surprises—being up-front and honest shows that you have good character.
Conditions is simply shorthand for how you will use the proceeds of the loan. How much do you want to borrow? What will you do with it? How will you pay it back? And, if your primary source of repayment fails, what do you have to offer as collateral or fallback for loan repayment?
I like to refer to capacity as cash flow, which is generally your primary source of repayment. Lenders will look at the operating cash flow of your business when determining your company’s ability to repay a term loan. Cash flow is defined as sales, minus operating expenses, plus depreciation and amortization expense, plus interest expense. The amount left over is the cash available to pay back debt. Some banks also subtract owners’ distributions. A term loan is a loan that is repaid through regular periodic payments, usually monthly. Lenders want to know if your company generates enough cash flow to cover the monthly loan payment. If you need a line of credit, lenders want to know if your company’s operating cash flow can support monthly interest payments; and if the collection of accounts receivable and/or sale of inventory can repay the principal amount outstanding on the line of credit within a one-year period.
Capital is cash invested by the borrower. Generally, banks will not finance 100% of the cost of an asset. You need to be prepared to make a down payment towards the equipment, building, business, or anything else you want to finance. Willingness to put some of your own money in is a sign of your commitment to the business. If you are not willing to commit to your own cash to your business; it is unrealistic to expect the bank and/or any potential investor to lend money or make an investment in your business. Commitment is closely linked to character, explained in point number 6.
In order to ensure that you have an alternative source of repayment, lenders want to see what kind of hard assets you have to secure the loan. Acceptable forms for collateral include accounts receivable, inventory, commercial and/or residential real estate, machinery and equipment and/or cash / marketable securities. IRAs are ineligible. If the collateral granted doesn’t quite cover the loan amount, an alternative may be a loan that carries a guaranty from the U. S. Small Business Administration (SBA).
Last, but not least, your character counts. Lenders need to make an assessment on how well you are at repaying your loan, and things like your reputation and all of the other “C’s” of credit. Examples of character include:
- The senior management team’s experience and ability
- The business owners’ willingness to personally guaranty the loan
- Being a law-abiding citizen
- A good personal and/or business credit history
Before applying for a loan, check your credit bureau report and review the “Six C’s of Credit”, which are important parts of your application. Are you ready to apply?