At GenWealth CapCo, our primary function is to find private financing for commercial real estate, however, we understand that some clients may need to obtain bank financing for other projects. When applying for a business loan, there are multiple factors that lenders look for in determining the creditworthiness of a client.

The 5 C’s of Credit are credit factors that help lenders determine whether to approve or decline applicants. The 5 C’s break down qualitative factors, such as government influences, as well as quantitative factors, such as debt to income, to determine the risk of a client.

Below are the 5 C’s of Credit and how to help strengthen your profile:

1. Credit/Character

The Credit or Character factor is your willingness to repay your debts. Lenders will review your payment history, check for any public records on your credit report, and analyze your credit utilization. A standard credit report will show installment loans such as real estate, vehicle, and student loans and revolving debt such as credit cards and/or home equity lines of credit (HELOC).

Credit worthy clients have on time payments, a report clear of collection accounts, and low balances on credit cards. The credit score is important, but it only serves as a benchmark. Some lenders may require a 700 credit score while others may go as low as 600. It is up to the client to do their due diligence to see which lenders can serve their needs.

To strengthen your Credit/Character factor, take a few things into consideration.

  • Make on time payments
  • Keep credit card balances low. A rule of thumb is to keep credit utilization less than 30%. When a client has high utilization and a lower score, it signals that an individual or business is using credit to finance their living or business expenses.
  • Avoid applying for several accounts during a short period of time.

2. Capacity

For major banks, Capacity is the most important factor to a client’s profile. Banks are cash flow lenders and will only lend at the amount that you can afford. Banks have minimum cash flow requirements and it does not matter if your credit score is 600 or 750, if you cannot afford the amount that you are requesting, a lender will likely Counter (change) or decline the request.

There are multiple ratios to discuss, however, the two basic ratios lenders use are the Debt-to-Income (DTI) ratio and Debt Service Coverage Ratio (DSCR).

Debt-to-Income Calculation: Annual Debt Service/Annual Gross Income (Pre-tax)

DTI is the percentage of your gross income that goes to pay your debt payments. The rule is, the lower the DTI, the better. Below is an example of DTI:

Monthly Debt: $2,000/month, your annual debt service is $24,000/year.

Gross Income (Pre-tax Income): $100,000/year

DTI: 24% ($24,000/$100,000)

Banks DTI range between 40-60%. In this scenario, you would be able to meet the minimum Capacity requirement.

Debt Service Coverage Ratio Calculation: Annual Operating Income/Annual Debt Service

Debt Service Coverage Ratio (DSCR) is a measurement of the cash flow available to pay debt obligations. In this case, the higher the DSCR, the better. This ratio is calculating the amount of income relative to debt. Most banks will use your Net Income plus any add backs such as Depreciation, Interest, and Amortization as your Annual Operating Income. For example:

Annual Operating Income: $70,000/year

Annual Debt Service: $24,000/year

DSCR: 2.92x ($70,000/$24,000)

The common metric for banks is between 1.15x to 1.50x. In this scenario, a DSCR of 2.92x would meet a typical bank’s minimum Capacity requirement.

To strengthen the Capacity factor, take a few things into consideration.

  • Contact your bank to verify how cash flow is determined. You may be able to afford more than you think.
  • Hire a financial advisor to help with planning and budgeting.
  • Keep your annual debts low. Avoid “overleveraging” and pay down debt if needed.
  • Try private/hard money financing to meet your lending needs. Private lenders are typically more aggressive.

3. Collateral

Collateral is an asset that a borrower is willing to use as security for a loan. In business banking, collateral is typically real estate, equipment, accounts receivable, or inventory. A bank will obtain a valuation of the asset and will lend a percentage of the value. Terms such as Loan to Value (LTV) is cited in regards to collateral. For example, an appraisal (valuation) shows that the property value is $500,000 and the Borrower is requesting a loan amount of $400,000. This would result in an 80% Loan to Value.

Loan Amount Requested: $400,000

Property Value: $500,000

Loan to Value: 80% ($400,000/$500,000)

Each bank has their own guidelines on how much they are willing to lend on Collateral. Regarding real estate, banks tend to lend 50% to 80% of the total collateral value.

To strengthen the Collateral factor, take a few things into consideration.

  • Obtain an accurate valuation of your asset. When using an appraisal for a commercial property, make sure the appraisal is with 6 to 12 months from the date of application.
  • Have additional cash/liquidity on hand. Additional liquidity can be used as a mitigant for more risky projects. The more money you can put down on a piece of collateral, the better your chances are in obtaining the loan.
  • Note, for most Hard Money loans, Collateral is the primary source of repayment. The lower the LTV, the better your chances are in obtaining financing.

4. Conditions

Conditions is the most judgmental piece of the underwriting process because it takes into consideration various amount of factors, such as governmental influence in your industry, recent changes in the company’s ownership, competition in the industry, etc. Essentially, what factors outside of the company’s operations can affect the ability of the company to repay its debt. Lenders ask various questions such as, has new government regulations effected the cost of materials? Are there any competitors that can offer a cheaper, more efficient product? Does your company have a contingency plan in case of retirement.

To strengthen the Conditions factor, take a few things into consideration.

  • Diversify your operations. Make sure that you have various suppliers and clients in case of emergencies. 
  • Adapt to the times. Stay ahead of technology and industry trends.
  • Plan for succession

5. Capital

Capital refers to the amount of money that you have on hand. Banks require their borrowers to have skin in the game, especially when regarding real estate. The more that you have to put down on real estate, a piece of equipment, or a business acquisition, the less risky the deal.  Capital is usually in the form of Cash, Stocks and Bonds, and Retirement. In certain instances, clients borrow on their existing lines of credit, obtain bridge financing, or conduct capital raises to increase their Capital.

To strengthen the Capital factor, take a few things into consideration.

  • Joint Venture with a partner. You may have industry knowledge, while your partner has the capital.
  • Liquidate collateral. This can be done by selling a property, a piece of equipment, or any collateral with value.
  • Wait until you have enough funds to obtain the right loan for you.

Obtaining a business loan does not have to be difficult. There are various ways to get financing if you know what Banks are looking for. As with anything, get with a trusted advisor to help you with your process. If you have any questions or inquiries on Hard Money loans for commercial real estate, email or call us. Our trusted advisors will contact you as soon as possible.