5 Cs OF CREDIT | HRU MIC

THE 5 Cs OF CREDIT

Capacity • Capital • Collateral • Credit History • Character

UNDERSTANDING YOUR CLIENT'S CREDIT QUALIFICATION

At HRU Mortgage Investment Corporation, we know that you strive to provide your clients with the right financial solutions, at the right time - including the potential offered by credit products. But only you know whether a credit product, such as a loan, is suitable for your client. And once you've decided that it is, the next step is to determine whether they'll qualify.

HRU Mortgage Investment Corporation uses the 5 Cs of Credit (Capacity, Capital, Collateral, Credit History, and Character) as part of our underwriting process. By understanding these components, you'll be able to assess the likelihood of your client qualifying for a loan — which can be a real time-saver down the road.

Think of the 5 Cs as a tool to help you understand your client's credit viability. Because at the end of the day, you want to ensure you're able to recommend credit products with confidence.

DETERMINE YOUR CLIENT'S CAPACITY

Can they handle the debt?

Capacity is the estimated amount of debt a borrower can carry, and is determined by a mathematical calculation known as their Total Debt Service Ratio (TDSR). TDSR shows the amount of gross income dedicated to the repayment of debt and indicates the amount of additional debt one could reasonably afford to carry. Here is a quick way to calculate TDSR:

Total monthly debt payments ÷ Gross Monthly Income x 100% = Capacity (TDSR)

Typical monthly debt payments include:

Housing [mortgage Principal & Interest plus property Tax (PI&T) or rent payments]
Loan payments
Credit cards (minimum of 3% of the borrowed amount on bank credit cards and 5% of the borrowed amount on store cards)
Lines of credit (minimum 3% of the borrowed amount on unsecured lines and interest only on secured lines)
Car lease payments, car loan payments

* Monthly living expenses such as utilities, cable, phone bills, etc. don’t need to be included in the TDSR calculation.

Typical monthly income includes:

Salary
Commissions
Self-employed net earnings
Net rental income

As a rule, TDSR (including the new loan payment) should be less than or equal to 44%.

ASSESS YOUR CLIENT'S CAPITAL

Do they have sufficient financial backup?

Capital is the measure of a borrower's net worth and demonstrates their ability to manage their finances and accumulate assets while repaying debt obligations. It is calculated by subtracting an individual's liabilities from their assets. Capital reassures lenders by providing alternative ways for the borrower to repay debt other than their monthly income.

Generally, the minimum net worth requirements depend on the amount of the loan. Using our example of an individual applying for a $100,000 investment loan, the applicant's net worth is greater than the minimum net worth requirement(1x the loan amount) and therefore, is more likely to qualify.

Total Assets - Total abilities = Net Worth

Networth minimums for fully-funded loans (e.g., 100% loans):
≤ $100K - 1 x the loan amount
> $100K - 1.5 x the loan amount
> $250K - 2 x the loan amount

Items that qualify as assets

A home (registered in the name of the applicant)
Registered plans (RRSPs, RRIFs, etc.)
Tax-free savings accounts (TFSA)
Mutual funds (non-registered)
Stocks (that trade on major stock exchanges)
Savings accounts
GICs and bonds

Items that do not qualify as assets

Home furnishings
Works of art
Jewelry
Leased vehicles

Typical liabilities

Mortgages
Personal loans
Credit card debt
Line of credit balances
Leases
Amounts owing to the Canada Revenue Agency
Child support/alimony

* Your client can check their credit report to ensure that inaccurate or out-of-date liability information is corrected.

LOOK AT YOUR CLIENT'S COLLATERAL

Can their assets back their debt?

Collateral is a pledge of property or other assets that an individual uses as security against borrowed monies. The relationship between the value of these assets and the amount of the loan is called the loan-to-value ratio (LTV) and is expressed as a percentage:

Loan Amount ÷ Collateral Value x 100% = LTV(%)

Loan Amount: outstanding principal + accrued interest

Collateral Value: the total dollar amount of collateral

In general, products such as mortgages and home equity lines of credit are secured by a person's home, and investment loans are secured by the mutual or segregated funds that are purchased with the loan proceeds.

REVIEW THEIR CREDIT HISTORY

How have they managed credit in the past?

Credit history is a collection of information about a client's past behavior in meeting debt obligations. Together with this information, lenders use scoring systems such as credit score and other statistical assessment tools to help determine the credit risk and creditworthiness of a potential borrower.

Factors that contribute to the development of a credit score

Time in the file (usually, the longer the better)
Number and type of accounts (e.g., loans, lines of credit, credit cards, etc.)
References to accounts paid as agreed
Residence status
Derogatory information (e.g., late payments)
Bankruptcies, wage garnishments, liens, collection items
Requests for new credit
Level of the utilization of available credit

Items that do not qualify as assets

Making loan payments on time
Paying down revolving credit card debt
Maintaining moderate utilization rate on credit cards
Refraining from credit card consolidations
No bankruptcies, collections or judgments

Typical liabilities

Opening multiple credit products in a short period
Borrowing from a finance company
Regularly reaching or exceeding credit card limits
Closing seasoned, well-paid accounts

A Credit Score typically falls between 600 and 900. The higher the number, the better.

KNOW YOUR CLIENT'S CHARACTER

Do they have good habits?

Underwriters also assess the character of an applicant which is based on a number of factors. This includes the stability of their career and residence, and their willingness to provide complete and accurate information.

Questions to ask:

Has your client used credit before?

Past behaviours often predict future tendencies. If an individual has successfully used credit in the past, it is a positive indication that borrowed funds will be repaid.

Do they pay their bills on time?

This shows their responsibility toward debt obligations. If an individual regularly pays their bills on time, chances are they'll make their loan payments on time too.

Does your client have a good credit report?

Credit reports show a consolidated financial picture from various lenders. Solid payment history and prudent credit utilization are good behaviour indicators.

How long have they lived at their present address?

This provides an indication of a person's overall stability. In general, we prefer to lend to individuals who have lived at their present address for at least two years.

How long have they been at their present job?

This provides a further sign of a person's stability and also indicates their ability to continue earning a steady, reliable source of income.