Utah State

The 5 C's of Credit

The "5 C's of Credit" are the 5 key elements a borrower should have to obtain a loan. The loan officer analysis in any loan will revolve around the concept of Risk vs. Return. They weigh the risk in the loan against how much money the lender may possibly make on the loan.

If the risk is manageable and they can make a return on their investment they do the loan.  If there is so much risk that they stand a good chance of losing money and they can’t legally charge enough interest to cover the gamble, they don’t do the loan.  If there is very little risk, they do the loan and are willing to take a lesser interest rate to do business with you so you don’t take the deal somewhere else.

The 5 C’s are not the only criteria used but they are a good starting point so here they are…

  1. Character
  2. Capacity
  3. Capital
  4. Collateral
  5. Conditions


Character speaks to integrity. You will be asked about criminal records, prior SBA loans and your credit history. Most lenders have a difficult time loaning money to felons. Be prepared to explain any criminal convictions. A conviction last week will carry more weight than a conviction 30 years ago with a clean record in the interim. Bankruptcy is a deal killer. If you have one on your credit history, wait until it is expunged and then wait some more. You don't want a lender dealing with your bankruptcy.

Capacity relates to your ability to pay the new loan payment along with all of the other items which cause cash to flow out of your wallet and bank account. We call that negative cash flow. Cash flow coming into your pocket is called positive cash flow. If you are in a negative cash flow position, get out of debt and reduce your other expenses. Obviously, some cash will flow in from the business but, if you are in a position to make your payment without money coming from your startup operation, your loan officer will get a warm and fuzzy feeling.

Capital is analyzed by calculating your net worth. To do this, add up everything you own of value. We will call these assets. Now add up all of the debt you have. We will call this liability. Now, take the total asset number and subtract the total liability number. Your answer is your personal net worth. That is the amount of money we would get today if we took all your valuables, sold them and paid off all your debt. The bigger the better. If it's negative, you owe more than you are worth. A loan, more debt, will only make your situation worse so, the lender will be very reluctant.

Collateral is the amount of and more importantly, the type of assets that will be used to secure the loan. In other words, if you default on the loan and stop making payments, what will get repossessed? It is extremely difficult, if not impossible, for banks to loan money and use inventory as collateral. It makes them nervous to have you selling off their collateral. However, if you're not selling it then you're not making money. The other thing is that if they repo it, they will only get pennies on the dollar in a liquidation auction. Assets like land and titled equipment like vehicles are better.

Conditions of the borrower and the local and national economies are also important. If you are out of work and on the verge of losing your home to foreclosure, now isn't the time to borrow more money. If the local or national economies are in the dumpster, the bank will still loan money but you need to show how your business will buck the trend that is affecting everyone else.