Creditworthiness is a lender’s assessment of a borrower’s ability and willingness to repay debts based on their financial history and current financial situation.

Primary Implication

A lender will always establish the probability of a borrower defaulting on debt obligations to them before they approve any new credit.   When approving a business loan, traditional lenders analyze a business’s creditworthiness based on the five C’s of credit to gauge the creditworthiness of a potential borrower.  Fail to pass their credit evaluation and they will not extend financing to you.

Overview

Businesses that fall short in any of the following areas are categorized as “high risk” and will likely find it difficult to obtain a traditional business loan and will have to, instead, seek higher-cost alternative financing.

When approving a business loan, traditional lenders analyze a business’s creditworthiness based on the following five C’s of credit to gauge the creditworthiness of potential borrowers:

1. Character—reflected by the applicant’s credit history.  Banks want to lend to people who are responsible and keep commitments.  Recent late payments and other delinquencies can make you less creditworthy and, as a result, make it harder to get approved for financing.
2. Capacity—the applicant’s debt-to-income ratio.  The ratio is calculated by adding together a borrower’s total monthly debt payments and dividing that by the borrower’s gross monthly income.  The lower the ratio, the better the chance of qualifying for a new loan.  Most lenders are looking for a DTI ratio of 35% or less before approving an application for new financing.
3. Capital—the amount of money an applicant has.  Lenders are particularly looking for down payments to put toward the financing.  Generally speaking, larger down payment results in better rates and terms.
4. Collateral—an asset that can back or act as security for the loan.  Often, the collateral is the object one is borrowing the money for, referred to as secured debt.  As a result, loans that are secured by some form of collateral are commonly offered with lower interest rates and better terms compared to other unsecured forms of financing.
5. Conditions—the purpose of the loan, the amount involved, and prevailing interest rates. Lenders are also known to consider conditions that are outside of the borrower’s control, such as the state of the economy, industry trends, or pending legislative changes.

When dealing with a potential lender in addition to these five C’s, one more C can make a world of difference: Communication.  Your quick response to additional information requests and your willingness to communicate openly about your business opportunities and challenges is key to initiating a productive financial partnership.