How does a loan get approved?

If you need money to buy a car or house or want a new credit card, lenders will often look at more than just your credit score when assessing your ability to pay back money you borrow. 

Banks and credit unions will evaluate your creditworthiness (or how likely you are to pay back a loan if you borrow money) using what is referred to as the “5 Cs of Credit.” 

So what are the 5 Cs and why are they important? Make sure you know the answer before you start your next loan application.  

Here they are: 

Capacity refers to your ability to pay back a loan based on (1) how much debt you already hold and (2) your current income level. This is also known as your debt-to-income ratio. This ratio tells lenders what percent of your total (gross) pretax monthly earnings you can draw from to cover your existing monthly debts like car loans, mortgage or rent payments, credit cards, and other debts. Lenders vary on what they say is an ideal debt-to-income-ratio, but typically they suggest not letting your debt exceed a third of your gross income.  Sometimes this C is also referred to as “cash flow.” 

Conditions are the general aspects of a loan and how well they suit your borrowing capacity. This includes details like the length of time you have been employed at your current job or industry, how your industry is performing, the type of loan you are applying for (car, home, personal, etc.), the interest rate, the length of time you have to pay off the debt, and the total amount you are borrowing. All these details will be part of the decision a lender makes about your ability to pay off a loan. What you can do is ensure you have a solid reason for incurring debt and be able to show how your current financial position supports it. 

In addition to considering the conditions unique to the loan itself, lenders will also consider conditions that are beyond your control, such as the current state of the economy. 

Collateral refers to the assets you currently have that can be used to help you secure a loan and provide the lender assurance they can recover some of their funds if you can’t pay it back for some reason (also known as a loan default). In the case of a car loan, your vehicle itself is the collateral – if you can’t pay back the loan, the car will be repossessed. Same thing for your home. Note that not all loans require collateral, as in the case of unsecured credit cards and personal loans. 

Capital refers to how much money you have on-hand to put toward the loan. A larger capital investment by you decreases the chances of default.  This capital may be from other assets like investment accounts, savings accounts, and so on. Lenders also take this money into account as potential backup funds in case you are struggling to pay back your loan. 

Character is assessed by looking at your credit track record, also known as your credit history. This includes your credit score, which can range from 300 all the way up to 850. This score is impacted by factors like your history paying your bills on time as well as how much money you currently owe creditors (also known as your credit utilization ratio or the amount of all your credit balances divided by the total of your credit limits). Character also includes how long you’ve been using credit and what your existing mix of credit looks like. 

When applying for a new loan, it’s a good idea to take an honest look at the 5Cs of credit worthiness in your own financial history.  

The good news is that if you think your Cs could use some improvement, you have options. Credit unions like CAFCU offer tools and resources to help you raise your credit score and learn how to improve your chances of getting a loan.  

Here are some of the free financial resources we offer our members. This includes 1-on-1 credit counseling to monthly webinars on topics like credit repair and debt management.  

As a financial wellness advocate, CAFCU doesn’t just support our existing members. We offer free financial coaching to anyone looking for help. Even if you aren’t a current CAFCU member, you can schedule a free financial 1-on-1 with one of our certified financial wellness representatives.  

If you have questions about our lending products and services, contact our Lending team with your loan application questions by calling 1-800-359-1939, option 2, Monday-Friday from 7 a.m. - 7 p.m. CST.   

You can also learn more about our low-rate loans and credit cards and apply online at cafcu.org/loans. 

If you want a deeper understanding of the borrowing process, check out these related blog posts: