# 5 Cs of Credit: What They Are, How They’re Used, and Which Is Most Important

> **Definition**
>
> The five Cs of credit are five traits or characteristics used by lenders to assess a credit applicant's creditworthiness.

## What Are the 5 Cs of Credit?

The five Cs of credit is a system used by lenders to gauge the [creditworthiness](https://www.investopedia.com/terms/c/credit-worthiness.asp) of potential borrowers. The system weighs five characteristics of the borrower and conditions of the loan, attempting to estimate the chance of [default](https://www.investopedia.com/terms/d/default2.asp) and, consequently, the [risk](https://www.investopedia.com/terms/r/risk.asp) of a financial loss for the [lender](https://www.investopedia.com/terms/l/lender.asp). Lenders also use these five Cs—character, capacity, capital, collateral, and conditions—to set your [loan rates](https://www.investopedia.com/the-best-personal-loans-8761582) and loan terms.

### Key Takeaways

*   The five Cs of credit are used to convey the creditworthiness of potential borrowers, starting with the applicant’s character, which is their credit history.
*   Capacity is the applicant’s debt-to-income (DTI) ratio.
*   Capital is the amount of money that an applicant has.
*   Collateral is an asset that can back or act as security for the loan.
*   Conditions are the purpose of the loan, the amount involved, and prevailing interest rates.

![5 Cs](https://www.investopedia.com/thmb/xoX_fCfzXcXjSGMh0WVBFGY4_b8=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Five-C-479128409bd247e596d17bf7fb363b08.jpg)

*The 5 C's are Character, Capacity, Capital, Collateral, and Conditions. — Investopedia / Joules Garcia*

## How the 5 Cs of Credit Work

The five-Cs-of-credit method of evaluating a borrower incorporates both [qualitative](https://www.investopedia.com/terms/q/qualitativeanalysis.asp) and [quantitative](https://www.investopedia.com/terms/q/quantitativeanalysis.asp) measures. Lenders may look at a borrower’s credit reports, credit scores, income statements, and other documents relevant to the borrower’s financial situation. They also consider information about the loan itself.

Each lender has its own method for analyzing a borrower’s creditworthiness. Most lenders use the five Cs—character, capacity, capital, collateral, and conditions—when analyzing individual or business credit applications.

![The 5 Cs of Credit](https://www.investopedia.com/thmb/6VjI2nXc7GTudN9C-x12Zkc469o=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/investopedia5cscredit-5c8ffbb846e0fb00016ee129.jpg)

*— Investopedia / Alison Czinkota*

## 1\. Character

Character, the first C, more specifically refers to [credit history](https://www.investopedia.com/terms/c/credit-history.asp), which is a borrower’s reputation or track record for repaying debts. This information appears on the borrower’s [credit reports](https://www.investopedia.com/terms/c/creditreport.asp), which are generated by the three major [credit bureaus](https://www.investopedia.com/terms/c/creditbureau.asp): Equifax, Experian, and TransUnion. Credit reports contain detailed information about how much an applicant has borrowed in the past and whether they have repaid loans on time.

These reports also contain information on collection accounts and bankruptcies, and they retain most information for 7 to 10 years. Information from these reports helps lenders evaluate the borrower’s [credit risk](https://www.investopedia.com/terms/c/creditrisk.asp). For example, [FICO](https://www.investopedia.com/terms/f/fico-fair-isaac.asp) uses the information found on a consumer’s credit report to create a [credit score](https://www.investopedia.com/terms/c/credit_score.asp), a tool that lenders use for a quick snapshot of creditworthiness before looking at credit reports.

[FICO scores](https://www.investopedia.com/terms/f/ficoscore.asp) range from 300 to 850 and are designed to help lenders predict the likelihood that an applicant will repay a loan on time. Other firms, such as [VantageScore](https://www.investopedia.com/terms/v/vantagescore.asp), a scoring system created by a collaboration of Equifax, Experian, and TransUnion, also provide information to lenders.

Many lenders have a minimum credit score requirement before an applicant is approved for a new loan. Minimum credit score requirements generally vary from lender to lender and from one loan product to the next. The general rule is the higher a borrower’s credit score, the higher the likelihood of being approved.

Lenders also regularly rely on credit scores to [set the rates and terms of loans](https://www.investopedia.com/articles/personal-finance/120414/what-good-credit-score.asp). The result is often more attractive loan offers for borrowers who have good to excellent credit. Given how crucial a good credit score and credit reports are to secure a loan, it’s worth considering one of the best credit monitoring services to ensure that this information stays safe.

### Improving Your 5 Cs: Character

Prospective borrowers should ensure that credit history is correct and accurate on their credit report. Adverse, incorrect information can be detrimental to your credit history and credit score. Consider implementing automatic payments on [recurring billings](https://www.investopedia.com/terms/r/recurring-billing.asp) to ensure future obligations are paid on time. Paying monthly recurring debts and building a history of on-time payments help to build your credit score.

## 2\. Capacity

Capacity measures the borrower’s ability to repay a loan by comparing income against [recurring debts](https://www.investopedia.com/terms/r/recurring_debt.asp) and assessing the borrower’s [debt-to-income (DTI) ratio](https://www.investopedia.com/terms/d/dti.asp). Lenders calculate DTI by adding a borrower’s total monthly debt payments and dividing that by the borrower’s gross monthly income. The lower an applicant’s DTI, the better the chance of qualifying for a new loan.

Every lender is different, but many mortgage lenders prefer an applicant’s DTI to be around 36% or less before approving an application for new financing. It's worth noting that sometimes lenders are prohibited from issuing loans to consumers with higher DTIs as well.

For example, qualifying for a new mortgage typically requires a borrower have a DTI of 43% or lower to ensure that the borrower can comfortably afford the monthly payments for the new loan, according to the [Consumer Financial Protection Bureau (CFPB)](https://www.investopedia.com/terms/c/consumer-financial-protection-bureau-cfpb.asp).

### Improving Your 5 Cs: Capacity

You can improve your capacity by increasing your salary or [wages](https://www.investopedia.com/terms/w/wage-expense.asp) or decreasing debt. A lender will likely want to see a history of stable income. Although switching jobs may result in higher pay, the lender may want to ensure that your job security is stable and that your pay will continue to be consistent.

Lenders may consider incorporating freelance, gig, or other supplemental income. However, income must often be stable and recurring for maximum consideration and benefit. Securing more stable income streams may improve your capacity.

Regarding debt, paying down balances will continue to improve your capacity. [Refinancing](https://www.investopedia.com/terms/r/refinance.asp) debt to lower interest rates or lower monthly payments may temporarily alleviate pressure on your DTI metrics, though these new loans may cost more in the long run. Be mindful that lenders may often be more interested in monthly payment obligations than in full debt balances. So, paying off an entire loan and eliminating that monthly obligation will improve your capacity.

> **Important**
>
> Lenders may also review a lien and judgments report, such as LexisNexis RiskView, to further assess a borrower’s risk before they issue a new loan approval.

## 3\. Capital

Lenders also consider any capital that the borrower puts toward a potential investment. A large capital contribution by the borrower decreases the chance of default.

Borrowers who can put a [down payment](https://www.investopedia.com/terms/d/down_payment.asp) on a home, for example, typically find it easier to receive a [mortgage](https://www.investopedia.com/terms/m/mortgage.asp)—even special mortgages designed to make homeownership accessible to more people. For instance, loans guaranteed by the [Federal Housing Administration (FHA)](https://www.investopedia.com/terms/f/federal-housing-administration.asp) may require a down payment of 3.5% or higher, and nearly 90% of all [Department of Veterans Affairs (VA)](https://www.investopedia.com/terms/u/us-department-veterans-affairs.asp)\-backed home loans are made without a down payment. Capital contributions indicate the borrower’s level of investment, which can make lenders more comfortable about extending credit.

[Down payment size](https://www.investopedia.com/mortgage/mortgage-guide/down-payment/) can also affect the rates and terms of a borrower’s loan. Generally, larger down payments or larger capital contributions result in better rates and terms. With mortgage loans, for example, a down payment of 20% or more should help a borrower avoid the requirement to purchase additional [private mortgage insurance (PMI)](https://www.investopedia.com/mortgage/mortgage-guide/mortgage-insurance/).

### Improving Your 5 Cs: Capital

Capital is often obtained over time, and it might take a bit more patience to build up a larger down payment on a major purchase. Depending on your purchasing timeline, you may want to ensure that your down payment savings are yielding growth, such as through investments. Some investors with a long investment horizon may consider placing their capital in [index funds](https://www.investopedia.com/terms/i/indexfund.asp) or [exchange-traded funds (ETFs)](https://www.investopedia.com/terms/e/etf.asp) for potential growth at the risk of loss of capital.

Another consideration is the timing of the major purchase. It may be more advantageous to move forward with a major purchase with a lower down payment as opposed to waiting to build capital. In many situations, the value of the asset may [appreciate](https://www.investopedia.com/terms/a/appreciation.asp). In these cases, it would be less beneficial to spend time building capital.

## 4\. Collateral

[Collateral](https://www.investopedia.com/terms/c/collateral.asp) can help a borrower secure loans. It gives the lender the assurance that if the borrower defaults on the loan, the lender can get something back by repossessing the collateral. The collateral is often the object for which one is borrowing the money: Auto loans, for instance, are secured by cars, and mortgages are secured by homes.

For this reason, collateral-backed loans are sometimes referred to as [secured](https://www.investopedia.com/terms/s/secureddebt.asp) loans or secured debt. They are generally considered to be less risky for lenders to issue. As a result, loans that are secured by some form of collateral are commonly offered with lower interest rates and better terms compared to other unsecured forms of financing.

### Improving Your 5 Cs: Collateral

You may improve your collateral by simply entering into a specific type of loan agreement. A lender will often place a lien on specific types of assets to ensure that they have the right to recover losses in the event of your default. This collateral agreement may be a requirement for your loan.

Some other types of loans may require external collateral. For example, certain personal loans may require placing your car as collateral. For these types of loans, ensure you have assets that you can post, and remember that the bank is only entitled to these assets if you default.

## 5\. Conditions

In addition to examining income, lenders look at the general conditions relating to the loan. This may include the length of time that an applicant has been employed at their current job, how their industry is performing, and future job stability.

The conditions of the loan, such as the [interest rate](https://www.investopedia.com/terms/i/interestrate.asp) and the amount of [principal](https://www.investopedia.com/terms/p/principal.asp), influence the lender’s desire to finance the borrower. Conditions can refer to how a borrower intends to use the money. Business loans that may provide future cash flow may have better conditions than a home improvement loan during a slumping housing environment in which the borrower has no intention of selling.

Additionally, lenders may consider conditions outside of the borrower’s control, such as the state of the economy, industry trends, or pending legislative changes. For companies trying to secure a loan, these uncontrollable conditions may be the prospects of key suppliers or customer financial security in the coming years.

> **Fast Fact**
>
> Some consider the criteria that lenders use as the four Cs. Because conditions may be the same from one debtor to the next, it's sometimes excluded to emphasize the criteria most in control of a debtor.

### Improving Your 5 Cs: Conditions

Conditions are the least likely of the five Cs to be controllable. Many conditions like [macroeconomic](https://www.investopedia.com/terms/m/macroeconomics.asp), global, political, or broad financial circumstances may not pertain specifically to a borrower. Instead, they may be conditions that all borrowers might face.

A borrower may be able to control some conditions. Ensure that you have a strong, solid reason for incurring debt and be able to show how your current financial position supports it. Businesses, for example, may need to demonstrate strong prospects and healthy financial projections.

## What Are the 5 Cs of Credit?

The five Cs of credit are character, capacity, collateral, capital, and conditions.

## Why Are the 5 Cs Important?

Lenders use the five Cs to decide whether a loan applicant is eligible for credit and to determine the interest rate and credit limit. They help determine the riskiness of a borrower or the likelihood that the loan’s principal and [interest](https://www.investopedia.com/terms/i/interest.asp) will be repaid in a full and timely manner.

## Which of the 5 Cs Is the Most Important?

Each of the five Cs has its own value, and each should be considered important. Some lenders may carry more weight for categories than others based on prevailing circumstances.

Character and capacity are often most important for determining whether a lender will extend credit. Banks utilizing debt-to-income (DTI) ratios, household income limits, credit score minimums, or other metrics will usually look at these two categories. Though the size of a down payment or collateral will help improve loan terms, these two are often not the primary factors in how a lender determines whether to approve an application.

## Which of the 5 Cs Refers to an Individual’s Credit History?

Character refers to the composition of a borrower’s financial history and financial health. Character incorporates a borrower’s payment history, credit score, credit history, and relationship with prior debtors.

## What Are the Principles of the 5 Cs of Credit That Banks Operate On?

The main principle behind the five Cs is to gauge the risk of extending credit to a borrower. A lender needs to evaluate who they're lending money to, why the borrower is asking for money, and the likelihood of recovering loan proceeds.

Another principle of the five Cs is to determine how credit is priced. Borrowers with more favorable five Cs may get better terms, lower rates, and lower payments. Borrowers who are riskier with poorer five Cs may face unfavorable terms.

A lender also relies on the five Cs to determine whether they want to conduct business with a borrower. If a borrower’s five Cs are poor, then the lender may decline to extend credit.

## The Bottom Line

Lenders use certain criteria to evaluate borrowers prior to issuing debt. The criteria often fall into several categories, which are collectively referred to as the five Cs. To ensure the best credit terms, lenders must consider their credit character, capacity to make payments, collateral on hand, capital available for upfront deposits, and conditions prevalent in the market.

> **Article Sources**
>
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>     
> 2.  myFICO. “[What Is a Credit Score?](https://www.myfico.com/credit-education/credit-scores)”
>     
> 3.  VantageScore. “[About VantageScore](https://vantagescore.com/company/about-vantagescore).”
>     
> 4.  Consumer Financial Protection Bureau. "[What Is a Debt-to-Income Ratio?](https://www.consumerfinance.gov/ask-cfpb/what-is-a-debt-to-income-ratio-en-1791/)"
>     
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>     
> 6.  LexisNexis Risk Solutions. “[RiskView Liens & Judgments Report](https://risk.lexisnexis.com/products/riskview-liens-and-judgments-report).”
>     
> 7.  U.S. Department of Housing and Urban Development. “[Let FHA Loans Help You](https://www.hud.gov/buying/loans).”
>     
> 8.  U.S. Department of Veterans Affairs. "[VA Home Loan Types](https://www.va.gov/housing-assistance/home-loans/loan-types/)."
>     
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