Factors That Affect Credit Worthiness

Factors That Affect Credit Worthiness
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  • 0:03 Factors
  • 0:23 Capacity
  • 0:57 Character
  • 1:17 Conditions
  • 2:24 Collateral & Capital
  • 3:30 Lesson Summary
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Lesson Transcript
Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and is currently working on his PhD in Higher Education Administration.

Access to credit to pay for education, a house, a car or other items is an important part of managing personal finances. In this lesson, you'll learn what factors lenders consider when deciding whether to loan someone money and what interest rate they will charge.

Factors

Not all consumers are able to access the credit markets through mortgages, credit cards, auto loans or personal lines of credit. Lenders want assurance that the individuals they let borrow money will pay them back based on the terms and conditions of their agreement. When it comes to offering credit, lenders often refer to the '5 Cs.'

Capacity

Capacity refers to the financial ability of a borrower to pay back a loan. Let's compare two borrowers. They are both single and have no debt, but one brings home $5,000 per month and the other brings home $3,500 per month. Based solely on that information, the borrower that brings home $5,000 has more capacity. But, if that first borrower already has $2,000 in debt payments each month, giving them only $3,000 in discretionary income, the individual that brings $3,500 home each month would have more capacity.

Character

Character is difficult to measure, since it's really meant to reflect the personal reputation of the borrower. In some ways, this is what credit reports try to measure. They quantify the behavior of borrowers, such as whether the borrowers make payments on time, how many accounts they open, how they use those accounts and how much debt they are willing to accumulate.

Conditions

Conditions refer to two different sets of conditions. The first set contains the specific aspects of the loan, such as the term (length) of the loan, the interest rate and the principal (original amount borrowed). Lenders consider risks when making a loan, and the longer the length of the loan and the higher the principal, the higher the risk of the loan. The interest rate is how lenders charge for the risk they are taking on so, generally speaking, the greater the risk, the higher the interest rate. The interest rate can also be influenced by some of the other 'Cs,' such as character. Some lenders won't lend to people with credit under a certain score; others will, but will charge a higher interest rate.

The second set of conditions are macroeconomic conditions, which refer to the current conditions of the economy. In the early 2000s, the economy was growing and it was very easy to obtain a loan. In fact, many people would say it was too easy. After the financial crisis of 2008, it became very difficult for consumers or businesses to get loans, because the economic conditions had deteriorated so badly.

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