Learn three Cs of credit before applying for a loan

• Published July 03, 2008

When you're looking for credit, it's worth understanding what potential creditors are looking for when they're looking at you. Traditionally, they're looking for the three Cs: capacity, character, and collateral. Capacity

Potential creditors want to know whether you have the wherewithal to repay a debt. To this end, they'll inquire (usually on an application form) about your income information: How much is it? Does it come from wages, commissions, or some other source? Does it come on a regular or seasonal basis? On the flip side, they'll also want to know about your expenses, especially any debt obligations. In addition, they’ll want to know how many dependents you have and whether you’re required to pay any child support and/or alimony. Of particular interest to potential creditors is your debt-toincome ratio. This ratio compares your monthly recurring debt obligations to your monthly gross income. Your recurring obligations include your mortgage or rent, credit card payments, loan payments - including the one you're applying for - and alimony/child support you pay. Your income includes bonuses, commissions and any other income you receive, such as Social Security, pensions, and alimony/child support. Note: The debt-to-income ratio is also known as the backend ratio. A second ratio, called the front-end ratio, compares your rent or total mortgage payment to your gross income, and is used primarily to determine whether you qualify for certain mortgage loans. Your debt-to-income ratio goes a long way toward determining whether you are granted credit, how much and at what interest rates. While many other factors affect your capacity to repay a loan, lenders generally consider debt-toincome ratios of 35 percent or less to be ideal, 36 percent to 42 percent to be manageable, 44 percent to 49 percent to be risky, and 50 percent or above to be unacceptable. Character

OK, your sweetheart thinks you're the best thing since sliced bread, and your bosom buddy knows you’re one in a million. But that’s not the sort of character endorsement creditors are looking for. What creditors want to know is, given that you can repay a debt (capacity), will you? When it comes to your credit character, lenders often look for another C: consistency. Have you bounced around from address to address, or job to job? Doing so makes creditors nervous. Longevity in employment and residency indicate stability, and that’s what creditors like to see. Lenders also firmly believe that your past actions are a good predictor of your future behavior. So they’re looking to see whether you've used credit before, and what your repayment track record has been like. To do this, they rely primarily on your credit report and your credit score. Collateral