The 5 critical C’s of credit every investor must understand

By Marcel Greaux

To most Canadians, buying a property is a daunting task in itself, but what about securing a mortgage? For a real estate investor, that first property is the most difficult to acquire, partly due to a lot of internal fear and a lack of understanding about the process.

In my experience and observations over the years, I would say financing is the most stressful process in the acquisition phase (managing tenants is a nail-biting runner-up). But to gain some perspective into this world, it’s important to understand the way lenders think.

Learn how to play in the different sandboxes or jump through the different hoops. At the end of the day, each deal funded brings you closer to fulfilling your dreams. The five critical C’s of credit are aspects of the lending process every investor MUST become familiar with. It will get you closer to a “YES” and make the process of acquisition a lot less stressful.

So, what factors are taken into consideration by lenders and underwriters that can make or break the loan? Obviously, credit is a major decider in the equation, but what exactly goes into deciding credit worthiness?

Most Canadians aren’t aware that credit is not just a score or an ability to make payments on time, but is actually composed of a few different categories; hence, the five C’s of credit:

1. Credit shows the lender a snapshot of what the borrower’s repayment history has been over a period of time. This is the only way a lender can predict the borrower’s propensity to make future payments. The credit score is the primary measurement factor.

2. Capacity is the ability to repay loans. Arguably, this is the most critical of the five C’s of credit.  Lenders look at debt service ratios (total debt service and gross debt service), as well as payment history in order to assess a borrower’s capacity, or ability, to repay a loan. 

3. Capital is the amount of money that a borrower has invested in a property. It is otherwise known as a down payment. Lenders want to see how invested you are in a property before making a decision.  Loan-to-value is a measurement used to determine the amount of capital required as down payment, in addition to the rate and terms of the mortgage. 

4. Character can be described as a borrower’s general trustworthiness to repay loans. Factors such as length of employment and the borrower’s propensity to save and utilize credit responsibly all help to establish character.

5. Collateral can be thought of as additional security provided to the lender. The subject property itself – its value, location and characteristics – can be thought of as security, but collateral can also include outside parties that will guarantee the loan. These parties are often referred to as covenant partners.

The goal is to get a “YES” to your deal with a lender. The five C’s outlined above determine a borrower’s ability and willingness to make payments. Understanding what a lender is looking for allows you to set yourself up to put your best foot forward. If your investments are analyzed and planned correctly, every “YES” from your lender will bring your closer to achieving your goals.
 
Marcel Greaux is an active investor, mortgage agent and founder of The Toronto Real Estate Club

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