Understanding the 3 C's of Credit | Character, Capital & Capacity | Study.com (2024)

In the world of credit, there are three C's: character, capacity, and capital.

• Character - A lender may use one's credit history to determine whether or not a person is trustworthy and reliable enough to repay a loan. Considerations may include prior credit use, timely payment of bills, and the length of time a person has lived at their current home.
• Capital - To get a loan, a person needs to show that they've got the money to repay it if they don't have any revenue coming in at the moment. It is important to note assets that can be used as collateral for a loan or other financing are referred to as capital. An individual or business can own capital. This is to mean both capital and collateral qualify to be categorized as the three C's of credit.
• Capacity: This refers to someone's ability to pay back the debt. For a lender, it's important to know if a person has been consistently employed in a job that provides adequate revenue to sustain their credit utilization. An individual's company's capacity to repay loans is the most crucial of the five factors. One should ensure that their business strategy shows how they intend to repay any debts.

What is character in credit? Customers' propensity to pay on time, as indicated by their payment history, is referred to as character in credit. When determining a borrower's character, a lender will look at their trustworthiness, personality, and credibility. An applicant's financial responsibility and ability to make timely loan payments are the primary goals of this process. People's payment history has the greatest impact on their credit score. As a result, it is imperative to stay on top of one's financial obligations, as a single late payment can have a negative impact on one's credit rating. It's also a good sign to a lender or bank if a potential buyer pays their bills on time and manages their credit responsibly.

The character of a person asking for a loan is an excellent illustration of this. Having a good credit rating is a result of their ability to pay their obligations on time during the past six years. As a result, this individual has a greater possibility of receiving better conditions on their loans.

Credit capacity is the amount of credit a person has available to them. In other terms, it refers to a person's ability to repay a loan. Lenders utilize ratios to evaluate how much money they may lend to a person. One's recurrent monthly debt payments are divided by their monthly income to arrive at someone's debt-to-income ratio (DTI). To be eligible for the majority of loans, one will need a low DTI. For an individual to increase their credit rating, they must carefully pay off their credit card amounts and request greater credit limits. Become a registered user of the service.

Calculating a person's DTI is one way to demonstrate credit rating capacity. Consider the case of a homeowner making a $1,200 monthly mortgage payment. Additionally, they have a $600-a-month automobile loan payment. Since he pays off his credit cards each month, he owes nothing but the minimum payments on his other accounts. An individual making $8,000 per month's DTI is ($1,200 + $600) / $8,000 = $1,800 / $8,000 = 0.225 = 22.5 %. Therefore, they will probably be able to get more credit because of this, and his DTI is low.

Certain types of loans necessitate the use of collateral, such as a house or automobile. If a borrower fails to pay back a loan on time, the lender is authorized to confiscate the collateral they have provided as a form of security. Collateral is a technique for a lender to assure that a borrower will pay back a loan in full or to recover its losses in the event of a default. If this asset backs a secured loan and the borrower pays it back on time, it might indirectly help improve credit. Since payment history heavily influences a person's credit score, keeping up with all personal accounts and making on-time payments is essential. Credit history, the availability of sufficient funds for repayment, and the presence of collateral are all considerations in obtaining credit.

Taking out a mortgage is an example of collateral. Most banks want collateral in the form of a vehicle or a property before they lend money to someone.

When it comes to economics, credit is defined as an agreement between two parties. Character, capital (or collateral), and capacity make up the three C's of credit. Credit history, sufficient finances for repayment, and collateral are all factors in establishing credit. A person's character is based on their ability to pay their bills on time, which includes their past payments. By capacity, we mean the maximum amount of money that an individual or company can borrow and then pay back over the loan term. Financing is not an option for people if they cannot repay the debt. Using the 3 Cs, a borrower's ability to repay a loan, and the collateral used to secure the loan, one can establish creditworthiness (capital). As a result, it assures that the individual is able to repay the debt and is motivated to do so. An individual or business's assets that could be used as collateral for a loan or other financing are known as capital.