The five Cs of credit and risk-based pricing
The five Cs are, in reality, just another form of the standard ‘know your client’ approach used to some degree by all financial institutions. This process is critical in the application of risk-based pricing, where the interest rate offered by the financial institution reflects the credit risk associated with a particular file.
Understanding each of the five Cs will provide you with a better view on how underwriters will view your application.
Character
An applicant’s character, including credit history and credit score, is the primary means by which underwriters evaluate the creditworthiness of an individual. This is an important indicator, and many lenders will reject an applicant whose credit score falls below their threshold without any further review. Lenders also places significant weighting on credit scores, but in situations where an applicant’s score is lower than ideal, they want to review the circumstances leading to the credit downgrade.
Capacity
Capacity is about more than just income. Lenders want to see that the client has the ability to service the loan. This is especially important for those with irregular incomes, as this involves a much deeper examination of income than simply looking at a couple of recent pay stubs.
Collateral
Collateral refers specifically to the property that is being purchased or refinanced. As the actual security for the loan, this is an important consideration, and underwriters spend significant time reviewing all aspects of the property.
Lenders require an accurate valuation of the property, and need specifics – including location, age and overall condition – to determine a value. It is also require to be verified by an approved third party.
In addition, they look at how the property conforms with the local neighborhood, as the surrounding area has a considerable impact on the true market value. They also take note of the pride of ownership a homeowner places in their home. It’s not a coincidence that those who take good care of their home tend to also have a good track record of repayment.
Capital
With respect to capital, lenders consider the type of employment and the applicant’s tenure in that position; available assets, including other properties and liquid assets; and overall net worth. As mentioned in the capacity section, for applicants with irregular incomes, available capital can be very helpful in bolstering the application.
Conditions
Finally, there are the conditions – the underlying aspects of the deal, including the terms of the mortgage and the supporting documents required to provide confirmation of the applicant’s finances, as well as the property itself. Because this touches on the other categories, the conditions is the element that brings all five Cs together to provide the complete story for underwriters.
Tying it all together
An experienced Mortgage Broker will guide you though all of these steps to put your best foot forward and obtain that valuable approval at the best rate and terms possible.
