5 Cs that determine your creditworthiness for getting a home loan
When it comes to financing a new home, the very first thought crosses our mind is opting for home loans. With multiple benefits associated, such as tax exemption, due diligence from the bank itself, liquidity; it seems to be the easy and secure option.
The transaction of home loans demands security from both the party i.e, lender (banks/NBFCs) and borrower (potential homebuyer). For homebuyers, a home loan is a safe option because it ensures enough liquidity and opportunity to let your funds grow. Similarly, banks granting home loans means an increase in their revenue. However, as you consider various factors before taking a home loan, banks also consider various factors before granting a home loan or should we say "secured" home loan.
Every bank or NBFC has its own protocol to follow before consenting home loans and it differs from bank to bank, not much though. Yet, there are the 5Cs that every bank considers before approving a home loan.
What are the 5Cs of the credit?
The 5Cs of credit refers to the system that is used by lenders to determine the creditworthiness of potential borrowers before approving their loans. It is an attempt to estimate the chance of default and, consequently, the risk of a financial loss for the lender. The five Cs of credit are Character, Capacity, Capital, Collateral, and Conditions.
Let's understand these 5 Cs thoroughly.
Character - The first C is "Character". The credit character of the individual is a crucial aspect. Your credit history and credit score, both play a significant role in determining your financial worth. The credit report of the individual presents both of these aspects and detailed information regarding the management of payments done by you over a time, including types of credit you have. The credit score serves as a risk indicator for the lender based on your credit history. Generally, the higher the score, the lower the risk and vice versa.
Capacity - The second C is " Capacity". It is a barometer that indicates your affordability to meet the EMIs per month. For this, lenders considered your gross income and the potential amount of disbursement to calculate the debt-to-income ratio. Often lenders prefer a borrower's DTI to be around 35% or less before approving an application for new financing, nonetheless, it can differ. They also check your income stability and type of income you earned. All these elements define your capacity to meet the liability of home loans.
Capital - The third C is "Capital". Your capital means your savings and investments. The intention behind this is to evaluate your financial soundness in case you lose a job or experience any other setbacks. Besides, if you pay the down payment without taking a loan, your chances of getting a home loan improve since it showcases your contribution on your own and that's exactly what banks and NBFCs look for, a potential to meet EMIs without depending on the regular income source.
Collateral - The fourth C is " Collateral". When you borrow a significant amount of money, the lender needs to know if they’re protected in case you don’t repay those funds, that's where collateral come into the light. A home loan is a secured loan that gives affirmation that if the borrower defaults on the loan, the lender can get something back by repossessing the collateral. Usually, the collateral is the thing for which you are taking a loan, meaning in case of a home loan or new home will act as collateral for the lenders.
Conditions - The fifth C is "Conditions". The lenders want to know how you are going to utilize the amount and will assess the purpose of the loan. A lender prefers to sanction loans that have a specific purpose. Besides, they may also consider other elements which are out of the hand of borrowers such as the state of the economy, industry trends etc.
These are the 5Cs of the credit, which every potential home buyer should be aware of. These Cs together determine whether you are eligible for the home loan or not. Since now you know what you need to have the home loan, you better prepare for it and fulfil your dream of owning a home.
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