How a commercial lender will evaluate your creditworthiness for a loan
When you apply for a commercial loan, lenders assess your credit risk based on a number of factors known as the “5 C’s of Credit.” Understanding these factors will help you build your personal and company credit standing while ensuring your ability to obtain credit when your business needs it most.
Here is a breakdown to help you better understand these factors and what all lenders look for:
Character: Qualifying for different types of credit hinges largely on your credit history — how the business and you personally have performed on previous debt obligations. Have you historically honored your financial commitments by paying as agreed? Do you exhibit strong integrity?
In addition to the credit report, lenders will use your personal credit score – usually between 300 and 850 – as a risk indicator of how you will perform in repaying the requested debt. The higher the score, the lower the risk.
Other factors in reviewing “character” include your industry experience and knowledge, strength of your current management team and how you and your business approach the other C’s of commercial lending.
Capacity: Lenders are in the business to lend. In order to lend, they must find borrowers who can comfortably afford making their loan payments. Your income (aka: cash flow) and company history indicate your ability to repay outstanding debt. “Debt service” is the calculation of your ability to repay expressed as a ratio. Each lender has a desired debt service coverage ratio. This ratio is an indicator of the company’s ability to service its debt requirements even during times of unexpected fluctuations in cash flow. Capacity is referred to as the Primary Source of Repayment.
Collateral: Loans, lines of credit, or credit cards may be secured or unsecured. Collateral can be cash, commercial real estate, equipment (including vehicles), inventory or accounts receivable. It is a safeguard to the lender but not the primary source of repayment. Collateral is referred to as the Secondary Source of Repayment; in the event of default it can be liquidated to repay the loan.
Capital: Your “skin in the game.” Capital represents the investments you have personally made into the company and what you have at risk to lose if the company should fail. Lenders look favorably on those who contribute to the company from their own personal assets and establish the business before seeking funding. Owners can raise capital by injecting their personal cash, retained earnings, private investors and/or government grants. 3
Conditions: The intended purpose of the loan falls under conditions. What will the loan proceeds be used for: working capital, commercial real estate financing, equipment purchase? Industry and economic conditions at the time of the loan request will also play a part in obtaining the requested loan. The lender will evaluate how these conditions could affect your business.
One final “Commercial Lending C” I like to include is Communication. Your willingness to communicate with your commercial loan officer can make all the difference. Every business has challenges and past difficulties. An honest back-and-forth conversation is instrumental in building your credit history and deepening your relationship with your banker. It’s not about the single transaction, it’s all about the relationship!
The 5 C’s of Credit are common in banking. Knowing the 5 C’s is only your first step. Understanding how you and your business measure up in each category and mitigating any weaknesses is your next step. Now that you have been enlightened on the 5 C’s, you can better prepare for questions you may be asked the next time you apply for credit. Happy hunting!
Grow Financial Federal Credit Union is one of the largest credit unions in the Tampa Bay area and has $2.1 billion in assets. Originally founded to provide a safe place to save and borrow money for the military and civilian personnel of MacDill Air Force Base, Grow Financial's membership includes employees of more than 1,100 businesses.