So you’re ready to get a mortgage. You’ve researched the neighbourhoods you love. You’ve toured your dream homes. You’ve even picked out paint colours. But in order to be fully prepared, you need to sort out your home loan financing.

And the best way to be fully prepared for that step is to understand the 5 Cs of credit.

The 5 Cs of Credit

The 5 Cs of credit (sometimes called the 5 Cs of banking) is simply an easy way to remember the framework that lenders use to determine whether or not you’re a good candidate for a home loan. The five Cs stand for character, capacity, capital, collateral and conditions.

A lender will use this system to set your loan terms and loan rate as well. And that means that it is very important to understand.

So what do each of the Cs mean?

Character

Character is generally considered the first of the 5 Cs of credit. In essence it refers to your credit history. But your credit history encompasses a wide range of factors that give insight into your borrowing reputation and whether you’re likely to repay your debts.

Why is it important to have a good credit score? The better your credit score, the higher chance you have of getting a home loan.

You can take a look at your credit file by requesting a credit report from a credit reporting agency, such as Equifax. It will provide personal information, your timeliness in repaying your current debts, loans and enquiries you’ve made over the last five years and any loans or accounts where you’ve defaulted (among other things). So, it’s always a good idea to know what your credit file looks like when you’re applying for a home loan.

In addition to your credit history, your lender will look at other elements of your ‘character’. This includes how long you’ve been in your current job, how often you change jobs and if you have any savings.

Capacity

The second C of the 5 Cs of credit is capacity. Capacity covers your borrowing power and lets the lender understand your ‘capacity’ – or ability – to repay the home loan.

To determine your capacity, lenders will look at your income, your debts and your expenses to work out whether you are actually able to make repayments without getting into financial hardship. They then use their assessment rate (also known as a serviceability floor or buffer) – which is higher than the national cash rate – to make sure that you’ll be able to make the repayments even if interest rates rise.

In this case, lenders will also ask whether your income is stable, whether it comes from a risky source (such as overtime) or whether you get money from other sources (such as child support).

Capital

Capital is the amount of money that you have available to fund your home purchase. In most cases this is what you’ve saved for your home loan deposit.

While officially you need to have 5-10% deposit for a home loan, in reality you need a 20% deposit or you’ll need to be prepared to pay Lender's Mortgage Insurance (LMI).

LMI is a one-off fee that protects your lender against potential loan defaults. The amount of the fee will depend on your lender and the size of your deposit. So the more savings you have – even if you’re not quite up to the 20% mark – the better off you’ll be generally. And if you’ve managed to save above the 20%, or have different types of savings, this also plays in your favour.

On the other hand, if you have a good income, but no savings, the lender will look at this as a bad sign. They might think that you’re too frivolous with your money or have too many expenses.

Collateral

This is any asset that you may have that could act as security for your loan. However, in most cases for a home loan borrower, this will be the new property that you’re preparing to buy. The bank looks at the property as security against your loan. If you default on your loan, then the bank can take back the property, sell it and recoup the money from the loan.

When looking at the collateral aspect of the 5 Cs of credit, they’ll certainly look at the property itself to analyse its suitability. There are certain properties that lenders may consider to be more risky, such as ‘off the plan’ units, studio apartments, small apartments or serviced apartments.

They’ll also look at the geography. Homes in rural, mining or tourist towns tend to have less saleability, which can also ring alarm bells for lenders.

Conditions

The conditions are pretty much anything else the bank wants to know about your finances and situation. A lender might consider the purpose of the loan, the amount that you’re looking to borrow and the current interest rates. They might want to know whether you’re a permanent resident or coming from overseas. They’ll even look at whether or not you’re about to grow your family.

These elements are designed to give them insight into any other factors that could impact your ability to repay the loan.

Getting Your Home Loan!

Every borrower’s situation is unique – yes, even yours! So if you don’t meet all the requirements of the 5 Cs of credit, don’t panic. There are certainly steps you can take and even lenders that may take into account certain additional factors, that will see you across the line.

Get in touch with one of our Lending Loop experts. We’re here to help you navigate all aspects along your home loan journey and can advise you on the right lender for your situation! Your home loan might just be a phone call away.