At some point, most of us need to apply for credit products, whether it’s applying for a mortgage to purchase your first home or financing the purchase of a vehicle with a car loan. Acquiring these assets would be impossible for many without getting into debt.
Potential lenders assess whether you are creditworthy based on a number of factors. These are sometimes referred to as the five Cs of credit.
Lenders will look at your employment history and your residence history. They are looking for stability. What they would like to see is that you are with an employer for at least two years and that you have lived at the same address for at least two years.
It is easier to qualify for certain types of credit and benefit from lower interest rates if you have an asset that you can pledge to the financial institution as insurance in case you end up defaulting on the loan. In the event of a default, the financial institution can then take control of the asset, which they can sell and use the proceeds to pay off the debt.
Capacity is all about your ability to pay the monthly payments. Lenders assess your capacity by comparing your current financial obligations to your gross monthly income, shown as ratios in two separate calculations, gross debt service (GDS) and total debt service (TDS). Lenders want to see a GDS ratio that is less than 32% and a TDS ratio that is less than 40%.
Along with your ability to meet the monthly payments, lenders take a look at your net worth. They are looking to see that you have other assets that you could sell or cash out in order to continue making your monthly payments in the event of a temporary loss of income.
Lenders obtain your credit history from the various major credit bureaus. They assess your credit score, the number of times you have applied for credit in the past, the number of active credit products that you currently have and the number of late payments on your existing and past credit products.
You may be weak on some of these factors and strong in others. Financial institutions vary in how they weight these five factors in order to assess your creditworthiness.