Last Updated: 2nd September, 2021
When you apply for a home loan, a lender will look at more than just your credit file. So what do banks and lenders assess when they look through your application? It’s the 5 C’s of credit.
What are the 5 C’s of credit?
The 5 C’s of credit is a framework that a lender will use to assess you as a borrower.
| The 5 C’s of credit | What does it assess? |
|---|---|
| Character | Your credit file Money management |
| Capacity | Whether you can afford the loan Stability of your income |
| Capital | Your assets and liabilities |
| Collateral | The property you’re buying |
| Conditions | Everything else about your situation |
Character
This refers to your financial conduct and financial history. Lenders will assess your credit file, savings history, employment history, etc. Your credit file is the main area of concern for the lender. The questions the bank will assess are:- Are you willing to pay the home loan?
- How long have you been in your current job?
- How often do you change jobs?
- Do you have any savings?
- Do you pay your rent on time?
- How often do you change your address?
- Do you pay your bills on time?
What if I have a bad history?
Try to make your repayments on time going forward. This is positive credit behaviour, and it looks great to a bank. There are specialist lenders who can help if you have a bad credit history. While the interest rate for a bad credit home loan might be higher, we can refinance you to a lower rate later, if you’re consistent with repayments. If you experienced a life event like divorce, illness or business failure two years ago and you’re borrowing less than 80% of the property, Home Loan Experts mortgage brokers can convince a lender to approve your home loan.Capacity
Capacity covers your borrowing power. The lender will look at capacity to gauge your means and your ability to repay the home loan. Lenders will assess your income, living expenses and current debts to work out if you can make repayments without getting into hardships. They will use an assessment rate to determine if you can make repayments even if there are sudden rises in interest rates. The questions the lender will ask are:- Can you make repayments without getting into financial hardship?
- Is your income stable?
- Are you earning riskier income types like overtime, casual shifts or bonuses?
- Do you earn overseas income?
- Do you get child support or worker’s compensation?
How can I show my capacity?
Some people may have a harder time demonstrating their means to a lender than others. If you are such an earner, there are things you can to do to demonstrate to the lender that you have the capacity to service a loan. If you’re self-employed, low doc loans are available, which allow you to prove your income with alternative documents such as bussiness activity statements, bank statements or an accountant’s letter. If your income is considered risky, like overtime, bonuses, commissions, etc, it’s about applying with a lender that will assess these incomes. If you want to change jobs, talk to a mortgage broker. Some lenders will not accept your application if you’re on probation with a new employer.Capital
The banks will look at your assets and liabilities and how much deposit you’ve saved for a home loan. Having a lot of savings is good, while too much credit-card debt is bad. Earning $300,000 annually but not having any assets is a signal to the lender that you’re frivolous with spending and have not saved much. Mortgage broker tip: When you’re applying, put everything you own in the application form. The more assets you have, the better you look.Collateral
Collateral refers to the property you’re buying. The bank will consider your property against the loan you secure, because if you default on your home loan, the bank will foreclose on your home to recoup the loss. The questions assessed are:- Do you have good security for the loan?
- Is the property a standard property?
What do banks consider standard property?
| Point of difference | Standard property | Non-standard property |
|---|---|---|
| Location | The property is in a capital city or major town | The property is in a remote area. |
| Condition of property | The property is in good condition and does not require major renovation work. | The property is in a depleted condition and requires major renovation work. |
| Land size | The size is under 2 hectares. | The land size is more than 2 hectares. This includes hobby farms on large blocks of land. |
| Apartment size | The apartment has more than 50m2 of internal area. This excludes car spaces and balconies. | The apartment has less than 50m2. |
| Number of units | There are less than 30 units in the building | There are more than 30 units in the building. |
- If the property is located near a high-voltage power line
- If the property is in flood-prone areas.
- If the property requires extensive repairs.
- Having a non-standard property does not mean your loan will automatically be declined. It’s just a little harder to get approved for a home loan.
- Applying with the right lender is vital. In some cases, you’ll need to save a larger deposit, and in very rare situations, there might not be a lender that will accept the property.
Conditions
This includes everything else about your situation and also external factors that can affect your application. The questions assessed are:- What is the purpose of your loan? (whether you’re buying a home or an investment property)
- Are you pregnant?
- Are you a temporary resident or living overseas?
- Is the economy stable?
- Is the industry you’re working in stable? Lenders use an algorithm to assess the riskiness of your application. They compare applications of borrowers similar to you and look at what they did in the past. If your score is low, there’s a high chance you’ll be declined. This is known as credit scoring and is different from your Equifax credit score — which considers only the information on your credit file. Mortgage broker tip: Fill in your application with your contact information and include everything you own. This helps with the bank’s scoring.
- Buy in another location
- Buy in your name instead of a trust
- Ask your employer to waive your probation period
- Having a larger deposit always helps. For instance, if you’re borrowing only 80% of the property value, banks are more lenient than if you’re borrowing up to 95%.
- You can mitigate past weak spots in one of the 5 C’s by doing particularly well in that area after the problem occurs. For example, if you have a default on your credit file, it’s a Character issue. To mitigate this, show evidence that you’ve paid rent on time over the last three years, which shows the strength of Character.
- If your lender does not assess bonus income, you can show evidence that you’ve been receiving bonus income for the past five years and get a confirmation letter from your employer that you will receive it in the future. Banks will not believe what you say without the documents and evidence to back it up.
- However, don’t give too many documents, as the lender will scrutinise each one, which could raise more questions.
Can instant pre-approvals be trusted?
There are some lenders that offer instant pre-approvals that take less than a day. These are advertised as ways to save time, as it seems like your application is assessed faster. However, these instant pre-approvals are done by a computer, not a credit analyst. Once you win at an auction or you’re ready to buy your home, your application will be thoroughly assessed. Since a credit analyst will check the 5 C’s at that point, your home loan could be declined, even following pre-approval.Can I get an exception to lending policy?
Each borrower’s situation is unique, so lenders will sometimes make exceptions to their credit policy, as they want you as a customer. You have to know if the policy is a hard and fast rule or there is some room for flexibility. Mortgage broker tip: Mortgage brokers can send scenarios to a lender and ask for their opinion before submitting an application. This can give you the comfort of knowing that you are likely to be approved.Example of how to mitigate issues with the 5 C’s
Let’s say you arebuying a property in a remote mining town in a family trust and you’re on probation at a new job. Any one of these circumstances on its own would be fine, but having all of them together limits the number of lenders that can approve your application. So what can you do? You have to change your situation to improve your chances of approval. Do at least one of the following:Which of the 5 C’s is the most important?
The 5 C’s of credit are taken as a group and cannot be assessed on their own. While some might argue that capital is the most important (since you need a deposit for your home loan), having a large deposit does not guarantee your application will be approved. Capital may be the first thing a lender checks, but the other 4 C’s will also be considered to assess your risk profile. You can mitigate a weakness in one of your 5 C’s with strength in the others. Suppose you have a bad credit history (Character weakness). In that case, you can strengthen your application by saving at least a 20% deposit (Capital), buying a property that’s accepted by most lenders (Collateral) and having a stable income (Capacity). All of which improves your chance of getting approved for a home loan.More ways to improve my chances of approval
There are many ways you can increase your chances of getting approved for a home loan:At Home Loan Experts, we have 50+ lenders who can cater to your circumstances. Our mortgage brokers are credit experts who can build a strong application and get you approved for a home loan. Call us on 1300 889 743 or enquire online today.
