The Five C’s of Credit

There are five key factors, or the five C’s of credit, that all major lenders assess when scoring loan applications and judging the creditworthiness of borrowers. Learning these components will help improve your eligibility and help set you up for success when applying for a loan to buy a business.

Character – The lender will start here by looking at the applicant’s credit history as well as education and business background. Do you have a good reputation and track record of repaying debts? Many lenders have a minimum credit score requirement before an applicant is approved for a new loan. These minimum scores can vary from lender to lender. The higher the credit score, the higher the likelihood of being approved. Secondly, do you have the necessary education and/or experience to operate the business you wish to purchase? Lenders, especially those providing SBA guaranteed loans, want to know that the buyer is set up to successfully run the business when the seller hands over the keys.

Capacity – The applicant’s debt-to-income ratio. This measures the borrower's ability to repay a loan by comparing income against recurring debts. Lenders calculate DTI by adding a borrower's total monthly debt payments and dividing that by the borrower's gross monthly income. The lower an applicant's DTI, the better the chance of qualifying for a new loan due to more liquidity. Each lender is different, but many lenders require the borrower to have a DTI of 35% or less.

Capital – The loan applicants amount of capital available. Having enough liquidity is a critical piece to being approved for the loan. A sizeable down payment shows the lender and the seller that you are serious and capable. Banks are reassured by the borrower having a larger personal stake in the success of the business. The amount you’ll be required to put down varies by both the type of funding and the business. For SBA 7(a) loans, the most common loan used for business purchases under $5,000,000, banks often prefer to see 20 percent down for existing businesses and franchises (with a 10 percent minimum).  Only the strongest of buyers and businesses qualify for the 10 minimum buyer injection.

Collateral – An asset acting as security for the loan. A common example of this is real estate. The bank will often take a lien against your primary residence to use as security in case the loan goes into default. Some loans are denied if there isn’t enough collateral to secure it – along with the other requirements.

Conditions – The purpose of the loan, the amount involved, and prevailing interest rates. Lenders want to be reassured that the business is viable and there’s a market for it. It is important to have a business plan that will prove you can be successful based on economic conditions and the history of the business owner.

Finally, ask yourself these questions before making a loan request.

 ·       Is my business following all local, state, and federal laws and regulations?

·       Have I studied my competition and industry trends?

·       Am I providing a needed product or service?

·       Am I committed to making my business succeed.

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