Need a loan? Knowing how banks scrutinize loan applications will improve your chances of success. Here are the 6 Cs of credit analysis.
Capacity
Capacity is cash flow, or the ability to pay principal and interest when due. While banks do look at your prior credit history, what they really want to see is the cash flow to safely cover the debt service on the requested loan. For real estate, banks want the ratio of cash flow (EBITDA) to debt service to be at least 1.25. For other industries, the desired coverage ratio can be much higher.
Capital
Capital is the money you have personally invested in the businesses. For real estate, banks want you to provide at least 20% of the capital. You must have skin in the game to obtain a loan.
Collateral
Collateral can be guarantees or additional forms of security, such as mortgage. In general, banks like to limit a loan to 70% of the fair market value of the collateral. Marketable securities and real estate make for good collateral. Personal property does not.
Conditions
Banks consider whether the foreseeable economic conditions favor timely debt repayment. The macroeconomic winds must be filling your sails.
Course
Course is your proposed use of the funds. Banks want to see their funds employed in a manner that will increase capacity, capital, and collateral. In other words, banks want the loan proceeds applied in a way that creates positive leverage for your business.
Character
The general impression you make on a lender is very important. This includes your education, work experience, and credit history. Also, it helps to understand financial statements and how your business looks from the bank’s point of view.
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