Mortgage lenders use a framework of five main factors when reviewing an approval request. The purpose of this system, known as the five Cs of credit, is used to assess your overall credit worthiness.

The five Cs of credit are character, capacity, collateral, capital, and conditions. By weighing these five characteristics and corroborating them with the loan conditions, a lender can determine your likelihood missing payments and therefore defaulting on the mortgage. The 5 Cs are all about the lender managing their risk.

So if you're in the market for a mortgage, it's important to understand how lenders use this criteria before you start exploring your options. A little planning goes a long way and it can be the difference between qualifying or being declined.

So let's have a look at the five Cs of credit:

1. Character

The first C is "character," it mostly has to do with how responsible you are with your finances. Lenders look at your credit history to track your record for repaying debts. All this information is available on your credit report. The two main credit report agencies in Canada, Equifax and TransUnion, contain information about how much you have borrowed in the past and whether you repaid your loans on time. These reports retain most information for at least 6 years. 

Lenders are typically looking for clients who show reliability and stability, who make all their payments on time. In contrast, they might be leery about lending to someone who regularly misses payments. It is important to note that they will also search your name online, look into your employment details and consider a few additional risk factors in their assessment of "character".

2. Capacity

Capacity (or cash flow) measures your ability to repay a loan by assessing your debt-to-income ratio. Lenders compare your income against your recurring debts to see if you can afford more credit. They use the stress test method for the mortgage and include all reoccuring monthly expenses as well. 

Typically, the lower your debt-to-income ratio, the better chances you will have in qualifying to borrow money. Besides examining your income, lenders also look at how long you’ve been employed at your current job and consider your future job stability. They also look at how much access to credit you have and your history of accessing it. 

3. Capital

The third C of credit refers to the capital you bring to the table. Typically, the more money you have for a downpayment, the less risk the lender takes to provide you with financing. They will be looking at the amount you have for the down payment and also your "fall back". This means how much you have available in liquid assets should you have a life event which impacts your income and your ability to repay the mortgage if your income changes. 

4. Collateral

Having collateral can help you secure a loan because it gives the lender assurance they can get something back by repossessing the collateral if you default on the loan. Collateral is typically the asset you're borrowing money for. Mortgages, for example, are secured by homes, while auto loans are secured by cars.

Debts that are backed by collateral are often referred to as secured debts or secured loans. These debts are less risky for lenders and come with lower interest rates than unsecured forms of financing such as credit cards or unsecured personal loans.

Collateral is significant to the lender. This is why an appraisal is often completed when you’re purchasing a property. The lender needs to assess the property value as well as the condition, as it becomes their collateral for the loan. Just because you think it’s the perfect “fixer-upper” doesn’t mean the lender will see it the same way!

5. Conditions

Conditions refer to how you intend to use the money you’re borrowing. And although the “final c” is more applicable to smaller loans than mortgage financing, the principle remains the same. Some lenders prefer to finance homes that will be owner-occupied. In contrast, other lenders specialize in financing rental or commercial properties. How you use the property impacts the lender’s decision to provide mortgage financing.

Loan conditions can also involve outside market conditions, which are not something you can influence or control. These would be economic drivers that might influence things like rates or a lender’s comfort level with lending in certain geographic areas.

So if you're in the market to get a mortgage, understanding the five Cs will go a long way in helping you to get approved. If you’d like to have an in-depth look at your finances, review your credit report, and discuss market conditions before applying for a mortgage, please contact me anytime! 

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