The Four Cs of Credit refers to the factors that lenders and financial institutions use to evaluate a borrower's creditworthiness before deciding whether or not to extend credit. The four Cs are Character, Capacity, Collateral, and Capital.
Out of these four Cs, the two Cs that have to do with earning potential and available cash are Capacity and Capital.
Capacity: Capacity refers to the borrower's ability to repay the loan. It is an evaluation of the borrower's current income and employment status, which gives lenders an idea of their ability to make timely payments. In the United States, lenders typically look at a borrower's debt-to-income (DTI) ratio to determine their capacity to repay the loan. The DTI ratio is calculated by dividing the borrower's monthly debt payments by their monthly income. A lower DTI ratio indicates a lower risk to the lender, making the borrower more likely to be approved for credit.
To determine a borrower's capacity, lenders also consider their job stability and length of employment. A borrower with a stable job history is considered less risky compared to a borrower who has recently changed jobs or is self-employed. Lenders also consider the borrower's source of income, including bonuses, commissions, and overtime pay, to ensure that the borrower can make timely payments.
Capital: Capital refers to the borrower's available assets or net worth. In the United States, lenders typically evaluate a borrower's capital by looking at their credit score, savings, and investments. A high credit score indicates a borrower's ability to manage debt and make timely payments, making them more likely to be approved for credit. Lenders also consider the borrower's savings and investments as a source of capital, which can be used to pay off the loan in case of unexpected circumstances.
In addition to evaluating a borrower's capital and capacity, lenders also consider the borrower's character and collateral when making a lending decision.
Character: Character refers to the borrower's credit history, which provides insight into their financial responsibility. In the United States, lenders evaluate borrowers' character by looking at their credit report, which shows their credit score, payment history, outstanding debts, and bankruptcies. A borrower with a good credit history is considered less risky compared to a borrower with a poor credit history.
Collateral: Collateral refers to the borrower's assets that can be used to secure the loan. In the United States, lenders typically require collateral for secured loans such as a mortgage or a car loan. The collateral serves as a guarantee for the lender, who can seize the assets in case the borrower defaults on the loan. Lenders evaluate the value and quality of the collateral before approving the loan.
In conclusion, the two Cs of credit that has to do with earning potential and available cash are Capacity and Capital. Capacity evaluates the borrower's ability to repay the loan based on their income and employment status, while Capital evaluates the borrower's available assets or net worth. Lenders also consider the borrower's credit history and collateral when making a lending decision. It is important for borrowers to understand the Four Cs of credit to improve their chances of being approved for credit and getting favorable terms and rates.
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