Lenders attempt to mitigate the risk of lending to borrowers by performing credit analysis on customers when applying for a new credit account or loan.
This analysis is based on the 5 Cs of Credit as follows:
Lenders must be sure that the borrower has the ability to repay the loan based on the proposed amount terms.
Lenders also analyze a borrower's capital level when determining creditworthiness. Capital for a business loan application consists of personal investment into the firm, retained earnings and other assets controlled by the business owner. For personal loans, capital consists of savings and investment account balances. Lenders view capital as an additional means to repay debt in case of any uncertainties in the income stream.
Conditions refer to the terms of the loan itself as well as any conditions that may affect the borrower. Lenders review conditions such as the strength and weakness of the overall economy and the purpose of the loan.
This refers to the borrower's reputation or record vis-a-vis financial matters. The old adage that past behaviour is the best predictor of the future behaviour is one that lenders devoutly subscribe to.
Personal assets pledged by a borrower as security for a loan are known as collateral. Business owners may use equipment or accounts receivables to secure a loan, while individual debtors often pledge savings, a car or a home as collateral. Applications for a secured loan are looked upon more favourable than otherwise because the lender feels a sense of reduced risk when there is a collateral.
