The 5 C’s of Credit: Beyond Your Credit Score

5 C's of credit

To qualify for a loan all you need is a good credit score, right? Wrong. Your credit score is only one thing creditors look at. Your creditworthiness depends on a lot more than a 3 digit number. Before lenders will approve your loan application they take a look at your overall financial profile. If you have a good credit score but you’ve been turned down for a loan, you probably failed to meet the 5 C’s of credit. But what are they and why do you need to know about them? 

What are the 5 C’s of credit?

The 5 C’s of credit is a method of risk assessment used by creditors to help them decide if they’ll lend to you. The 5 C’s represent your:

  • Character
  • Capacity
  • Capital
  • Collateral
  • Conditions

Lenders use this system to determine how likely you are to pay back the loan as agreed, or default and cause them to take a loss. Your credit score is only a snapshot of how you’ve managed credit in the past. The 5 C’s of credit help lenders predict how you will handle new credit in the future: the credit you are asking them to give you.


The first C in the 5 C’s of credit; character. When creditors pull your credit file the first thing they look at is your payment history. Whether or not you make your debt payments on time says a lot about your character. Missed payments tell creditors you have a habit of not honouring your word. After all, a loan is a legally binding contract. You promised to repay your previous lenders a certain amount by a certain day each month. Then you sealed that promise with your signature. A missed payment is a breach of contract. They also look for collection items, judgements or a past bankruptcy. If you have missed payments, or a previous lender sent your account to collections or took you to court, that’s strike one. And it’s a big one. 

Lenders then move onto your residential and employment history. Frequent address or employment changes in a short period of time are a red flag. It signals to your lender that you might have a problem maintaining housing or holding down a job. That could mean you don’t keep up with mortgage or rent payments, and it calls your work ethic into question. Your ability to make your loan payments depends on your employment status. Job hopping and address changes are strike two.

Finally, your lender is also assessing how you interact with them. Your behaviour, body language, what you say and how you say it are all taken into consideration. If you are arrogant, evasive, or even overly talkative your lender may suspect you of fraud. At the very least, if you are belligerent or generally difficult to deal with your lender may choose not to lend you based on your attitude. If you are this difficult to lend to, you will be 10 x harder to collect from if you start missing payments. Strike three. Even most online lenders will need to speak to you over the phone at some point during the application process.


The second C in the 5 C’s of credit; capacity. The very next thing a lender will look at is your ability to pay. This is a specific calculation used to determine if you can afford a new monthly payment. It’s commonly referred to as your debt-to-income ratio. Your credit score measures your credit utilization ratio which is how much revolving debt you are carrying on your credit cards and lines of credit, but it doesn’t factor in the balances and monthly payment amounts on your installment loans. That’s why creditors need to look at how much you are paying each month in total debt repayments and compare it to your monthly income to determine your level of risk. Lenders will add up all your monthly debt payment obligations and subtract them from your gross monthly income. 

Generally, lenders want to see that you have no less than 36% of your income left over after all your debts have been paid. That means if your gross monthly income is $3,200 a month, you will need to have at least $1,152 left after you pay all your other monthly debt payment obligations. Anything less than that means you probably won’t be approved for a new loan. 

Here’s the thing, it doesn’t matter if you have a perfect 900 point credit score.  It really doesn’t matter if you make over six figures a year either. If you do not have enough disposable income your application will be denied. When you continue to take on debt, eventually your capacity to handle one more monthly payment will reach its breaking point. 

Don’t believe me? During my time as a lender, I rejected applications from people making almost a million dollars a year, working highly specialized prestigious jobs. When I crunched the numbers, I had more disposable income than the plastic surgeon I had to turn down for credit. This scenario plays out more often than you think. 

Lenders don’t just rely on these formulas for their own protection, it’s for your protection too. If a lender were to grant you a loan knowing full well you cannot afford the monthly payment, that’s the definition of predatory lending. You will default, the lender will take a loss, and your credit score will take a significant nosedive. Nobody wins.


The third C in the 5 C’s of credit; capital. If you passed the character assessment and the ability to pay calculation, lenders move on to something called capital. They take a look at what assets you have like savings accounts, investments, or even physical assets that can be converted into cash. The more money you have access to, the more financially stable you are. This is a key risk indicator that is not reflected in your credit score.

You wouldn’t be applying for a loan if you had enough of your own money on hand, but lenders like to see that you can provide some sort of cash injection, like a downpayment. If you’re applying for a mortgage or a car loan, for example, a bigger down payment will increase your chances of being approved. It will also help you secure a lower interest rate and other more favourable terms. 

If you have your own money on the line, you are far less likely to default on your loan. That makes you less of a risk to the lender. And since your own capital is at stake, it demonstrates to your lender that you are committed. If you were to default, it would represent a loss for both of you. 

Peeling back the layers a little more, those who have saved up a sizable down payment, or have accumulated assets, likely have a higher degree of financial literacy. They understand that money management is more than just paying bills on time. They are exercising personal finance principles like budgeting, saving, investing, and borrowing. Financial literacy and financial stability go hand in hand.


The fourth C in the 5 C’s of credit; collateral. Collateral is a financial term for liquid assets like savings and investment accounts, and physical items of value that are used to secure a loan. Your assets are not credit products so they do not report to the credit bureau. Your credit score does not reflect your financial profile beyond the debt you already have. When you secure a loan with collateral, you are giving your lender something of value in exchange for credit. If you default on your loan agreement, your lender has the right to take your collateral and sell it in order to recuperate some, or all, of their losses. That is why having collateral can reduce your level of risk to the lender and make you more creditworthy, but it falls outside the scope of your credit score. 

For example, your house is the collateral used to secure your mortgage loan. If you default on your mortgage, your lender can foreclose on your property and sell your house in order to recover some of their loss. Your car is the collateral used to secure your car loan. If you default on your car loan, your lender can repossess your car and sell it to recover some of their loss. Sometimes, for smaller personal loans a lender will let you secure your loan with miscellaneous household items like electronics or furniture. However, it is becoming less and less common to secure loans with small ticket personal items. If you default on your secured loan, it will report on your credit file as a repossession and may also appear as a judgement if your lender took you to court. That will have a major impact on your credit score. 

Secured loans give lenders peace of mind knowing that if the deal goes south, they are protected from a total loss. Borrowers are also far less likely to default on payments when there is something of value at stake. Secured, or collateralized loans are far less risky for lenders. Therefore, they can offer you a much lower interest rate and more favourable loan terms. And you’re more likely to be approved for a secured loan than an unsecured loan.


The fifth C in the 5 C’s of credit; conditions. Many lenders might list your residential and employment history here. But speaking as a former lender myself, many of us look at those as an indication of character. When it comes to conditions, we all take a step back to assess the whole picture. Your lender will take a look at context beyond the scope of your application and credit report. They’ll take into consideration things beyond your control. It may seem unfair but it is the only way to assess risk as accurately as possible. 

Lenders will consider the nature of your job industry, the current economic climate and government regulations, to name a few. And they will take into account the size of the loan you have requested, what you intend to use it for, the interest rate and the term. This is the part of the application where lenders put you under a microscope and ask themselves “does this loan make sense for Mr. Customer’s situation.” 

There are two critical reasons lenders use outside factors in their decision-making process. One, they need to mitigate risk as carefully as possible. They have a fiduciary responsibility to act in the best interest of the company and its shareholders. A fiduciary is a person or entity who takes care of money or other assets for another person or entity. Therefore, they are required to adhere to strict legal and ethical standards. After all, you are asking to borrow someone else’s money. Lenders are the custodians of money from shareholders investing in the lending market, and borrowers like you seeking access to credit. 

Second, lenders have to comply with anti-fraud and anti-money laundering legislation. Fraud and money laundering are types of financial crime. Fraud is a type of theft that uses deceit to trick victims into giving their money away. Money laundering is the process criminals use to make the proceeds of crime appear as though they came from legitimate sources. They use weaknesses in the banking system to make dirty money look clean. Without strict laws in place to reduce financial crime, people and financial institutions would suffer significant financial loss with limited means of legal recourse. Undetected money laundering leads to higher crime rates. There are many crime indicators that extend past the credit report. The banking industry is particularly vulnerable to financial crime. As industry professionals, it is our legal obligation to differentiate bad actors from legitimate applicants.

The 5 C’s of credit: why are they important?

The 5 C’s of credit are a critical tool for lenders. Without them, lenders would not be able to make an accurate risk assessment. Your credit score is only a report of how well you handled credit in the past. Lenders need to look outside the scope of your application to predict how you will handle new credit going forward. Without these important tools for mitigating risk, many lenders could not afford to stay in business. That’s bad news for borrowers. You would have few borrowing options and interest rates would increase considerably. An accurate risk assessment benefits everyone. It protects you from predatory lending while ensuring borrowers have access to competitive lending products with fair interest rates.  The 5 C’s of credit; it’s just good business.

Heidi Unrau is a senior finance journalist at Hardbacon. She studied Economics at the University of Winnipeg, where she fell in love with all-things-finance. At 25, she kicked-off her financial career in retail banking as a teller. She quickly progressed to become a Credit Analyst and then Private Lender. This hands-on industry experience uniquely positions her to provide expert insight on loans, credit scores, credit cards, debt, and banking services. She has been featured in publications such as WealthRocket, Scary Mommy, Credello, and Plooto. When she's not chasing after her two little boys, you'll find her hiding in the car listening to the Freakonomics podcast, or binge-watching financial crime documentaries with a bowl of ice cream. Fun Fact: Heidi has lived in five different provinces across Canada and her blood type is coffee.