June 19, 2007, 1:26 am

The Way Banks Look at You Part1: The 5 C’s

by: The Financial Blogger    Category: Banks and You
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In this series, I’ll show the perception from the person who is on the other side of the counter; the banker’s view. Many people are not quite sure why they are declined for a credit application or why a line of credit is not the right product for them as they want to consolidate their debts and benefit from some flexibility. We’ll start with the 5 C’s; Character, Capacity, Capital, Collateral and Conditions.

 

Character

The main character of the famous show “I need credit” is you. Who are you? The bank look at your age and income compare to your net worth. If you are an engineer for the past 5 years making 90K and you have a net worth of 20K, you better have a good story to tell your banker. If not, the bank will conclude that you have bad spending habits and incapacity of saving. Do you pay your bills on time? Your credit bureau will spill the beans if you are shy about your personal information. Everything is in there. There are no places to hide, better tell the truth right away. Financial institutions will also look at your marital status, type of employment and time of employment to determine your stability as an individual. If you are married with two kids and work for the same employer since 2002, you show great stability. Banks love that!

 

Capacity

How much do you earn? And even more important; how much do you spend already? You can see an example of how to calculate your Total Debt Servicing Ratio on this blog. Your banker will look at two things; what is your debt ratio now and what will it be after they grant the loan. If you have doing a consolidation loan, they will calculate your TDSR after consolidation without taking in consideration your existing debt. However, they might ask you to close your existing debts in order to make sure you don’t replicate history. If you don’t have a standard source of income (self employed, business owner, rental properties, etc), I strongly suggest you bring as many supporting documents you can find. The more information you have on your sources of income, the more likely the bank will consider an accurate amount.

 

In the case of rental income for example, they will more likely take half of your rental income minus your full mortgage payment and other maintenance fees. However, if you provide them with statement of rental profit/loss from your tax report showing steady revenue, they will take them in consideration. Therefore, you won’t be penalized for having non standard source of income.

 

Capital

Now we are talking about you net worth. Please note that your cars and furniture don’t really count in your net worth. The bank will surely put your car value in the balance sheet. However, as it is a highly depreciative asset, it won’t make the difference between a declined file and an approval. Are you house rich as many middle class Americans that bought their property at the right time or do you have liquid assets such as non registered investments?

 

Having a high net worth is not all. If you hold liquid assets, you will be in a much better situation to face rough financial times. As weird as it may seems, banks will prefer to see a flex line balance of 20K and investments worth 25K than no debts but a small 5K sitting in your investment portfolio. Both examples show the same net worth but one is showing more liquidity.

 

Collateral

This point is directly related to net worth. If you have liquid asset or a property, the bank might want to take them as collateral to secure the loan. It will reduce their risk of default and they will give a better rate to compensate the security. If you don’t plan on using those assets in the near future, offering security is a nice way of having your loan on the spot and benefiting from a better rate.

Secured loans are easy to approve for banks and they reduce their risk of no payment. By taking a lien on your assets, they have the possibility to cash them in and pay your debt among the proceeds of the sell.

 

Conditions

What are the overall conditions of your situation and the economy in general? If housing market is good, banks will more likely approve mortgages and line of credit. Banking is all about risk management. When the market is good, you lend. When it’s turning sour, you press on the breaks and you wait to see what is going on. There is no need to take unnecessary risks in period of recession. If you read between the lines, you should get credit now as the overall economy is good and banks feel safe about their credit portfolio.

 

This concludes my first post of this series of articles about the banks perception of individuals. As banks are complex companies with a different way of seeing things, make sure to stay tuned for more information.

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Comments

Great post, it’s great to see how banks look at potential clients.

Good post. I would add to your point about bringing documentation- if you are self-employed, bring more than you think is necessary and bring it for at least 2-3 years back.

by: The Financial Blogger | June 19th, 2007 (4:25 pm)

MDJ, this is only the beginning. You could be surprised to know how it works inside the vault 😈

TMW, I agree with you. Being self-employed has a lot of advantages; however, you better show a solid file with 2-3 years history when you go at the bank!