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How does a lender decide to lend?

by Tim St Vincent

People often want to improve their credit score prior to getting a big loan. Maybe they want help with renovations, a car purchase, a line of credit, or that big purchase we all dream of – and are a little scared of – a house. Just how does a lender decide if they are going to lend you money? Yes, your credit score is a part of that decision, and a very important part, but there are many other factors that they look at as well. Let’s chat about them a bit. Lenders also look at the Five C’s of credit, debt ratios and, of course, your credit score.

The Five C’s of Credit


When lenders evaluate character, they look at stability – for example, how long you’ve lived at your current address, how long you’ve been in your current job, and whether you have a good record of paying your bills. If you want a loan for your business, the lender may consider your experience and track record in your business. It certainly never hurts for your lender to know you well as a person.


Capacity looks at how much total debt the lender thinks you can manage, and how much of that debt you’ve already taken on. For example, if they think the maximum debt you can handle is $100,000 and you already have $40,000 of debt, then you are at 40% of your capacity. This measure looks at your debts and expenses to determine your likelihood of repaying new debt. Creditors evaluate your debt-to-income ratio, that is, how much you owe compared to how much you earn. The lower your ratio, the more confident they are in your capacity to repay new debt.


Capital refers to your net worth – the value of your assets (what you own) minus your liabilities (what you owe). Your assets can include things like your car, house, cash, and investments. From this they subtract how much you owe on these and others debts.


Collateral refers to any asset (possession) of a borrower, for example, a home, that a lender has a right to take ownership of and use to pay the debt if the borrower is unable to make payments as agreed. This is called a secured loan, as the loan is “secured” by the asset (typically the item purchased, but not always). By securing the loan with the asset, the lender has the right to take the asset away should the borrower become late in making payments. It is like having a tiny, invisible magical string connected to the secured asset; if you get behind in making payments the lender has the right to pull on this invisible string and take the secured asset away. If we are talking about a car this is called repossession, if we are talking about a house, this is called foreclosure. In each case, the asset (car or house) was used to secure the loan with a promise. The promise being: “If I don’t pay, you can take it away.”


Lenders consider a number of outside factors beyond the borrower’s control that may affect their ability to repay. For example, what’s happening in the local economy. If the borrower is a business, the lender may evaluate the financial health of the borrower’s industry, their local market, and competition. If interest rates are high overall, what impact does this have on the borrower’s business? Are the markets in a tailspin and are lenders generally in a mood where they don’t want to take on a lot of risk through lending? Some lenders may require a guarantor in addition to collateral. A guarantor means that another person signs a document promising to repay the loan if you can’t.

In addition to the Five C’s, there are many ratios that lenders look at when making a lending decision. One of the most common is the “debt service ratio.” In this ratio your total monthly debt payments (housing and all other debt payments) are divided by your gross family income (before taxes and other deductions). The goal here is to see what percentage of your income is consumed by your debt. Depending on which financial institution you go to and what you are looking to borrow for, they like to see you anywhere within a range of 33 per cent to 40 percent of income consumed by debt. The lower the percentage the better.

Finally, there is your credit score. We have chatted about that in several past articles and will again in the future, for now I will just leave it with saying that the closer your score is to 900, the better.

As you can see, the decision to lend money has a lot more behind it than just the credit score, though that is a key component. If you are going to apply for a loan, it is important to understand all the factors that go into the lending decision, and to do your best to make sure those factors are in your favour.

Tim St Vincent is a retired CFP and is a Certified Educator in Personal Finance with the Credit Counselling Society, a non-profit organization. If you wish to contact the Society for further information, assistance or to attend a webinar, please call 1-888-527-8999 or visit or

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