March 31, 2021 |Loans
Get the credit you need
Understand the 5 C’s of Credit before you apply for a loan
Farming costs add up quickly. Equipment, seed, fertilizer, livestock — the list goes on. If you’re like most farmers and ranchers, you’ll need to borrow money at some point to fund these expenses.
To get the capital you need, it helps to understand how credit decisions are made.
Most lenders, including Texas Farm Credit, consider five criteria — known as the Five C’s of Credit. These are used when reviewing a loan application and setting a loan’s terms and conditions.
Understanding these key factors can help prepare you to meet with your loan officer:
1. Character – the borrower’s dependability and integrity
Character is important. Texas Farm Credit needs to know you can be counted on to pay back the money you borrow. Other factors generally can’t compensate for a weak character score, no matter how much collateral or capital you have.
To assess an applicant’s character, lenders look at repayment history, credit reports and business and personal references. So, it makes sense to check your credit score and take care of any problems before meeting with your loan officer. Also, take time to organize your financial records and business plans into a professional package.
2. Capacity – the applicant’s financial capacity to repay the loan and meet all financial obligations
Capacity includes your ability on an annual basis to make your loan payments and pay vendor invoices and taxes — plus family living expenses. A general rule of thumb is to exceed a 1.1:1 capacity ratio, at a minimum. In other words, after living expenses and taxes are covered, lenders look for at least $1.10 of income for every $1 of debt.
Income is based on a conservative projection of revenues, including crop sales, nonfarm income, etc. To allow for adverse events, funds available to service debt should be at least 1.25 times the amount of term debt payments you have coming due in the next year.
3. Capital – the applicant’s liquidity and solvency
Your lender needs to know you have enough equity in your assets to secure operating loans and take care of unexpected circumstances. In general, 50 percent owner equity is a good target, although the percentage will vary based on the nature of the loan. To determine owner equity, divide your net worth (assets minus liabilities) by your total assets.
4. Collateral – the physical property that will minimize the lender’s risk in the event of loan default
Texas Farm Credit ranks collateral toward the bottom of the credit criteria. We really don’t want to take a piece of collateral. However, if things don’t work out well, collateral protects Texas Farm Credit from losing too much money.
The collateral required for a loan is very dependent on the specifics of your loan request, and is typically the property you’re financing. However, be prepared to discuss what you’re able to offer as collateral. And provide as much detail and documentation as you can about its value and condition.
5. Conditions – the conditions for granting and repaying the loan
Agriculture is a volatile and often cyclical industry. Therefore, your lender must be concerned about the conditions and outlook for your sector of the industry and how well your operation is prepared to survive and thrive. For instance, if you’ve maintained a reasonable financial position during tough conditions in the past, you’ll likely manage conservatively during good times, knowing that a downturn is possible. Texas Farm Credit loan officers will try their best to set a loan repayment schedule that is reasonable and fits your income stream.
You’ll be in a better position to get the credit you need if you think about the Five C’s and how they apply to your operation — before you meet with your loan officer. Alternatively, address them in writing and submit your analysis with the loan request.
Rest assured, Texas Farm Credit is here to work with you. We look forward to helping you accomplish your goals through the good times and the bad.
Frequently Asked Questions
The 5 C’s of credit are: Character, Capacity, Collateral, Capital, and Conditions. This is the informal group of top priorities that a majority of lenders closely examine as part of a loan’s underwriting process. These factors are analyzed and quantified to streamline creditworthiness determinations.
- Character refers to a person’s history of on-time payments.
- Capacity refers to the amount of new debt a person can adequately take on.
- Collateral refers to the property or assets used to secure a loan, and the resale value of those things in the event they must be liquidated.
- Capital refers to a person’s overall financial control and ability to amass liquid cash.
- Conditions refers to the exact details of a proposed loan agreement, including such factors as interest rate, term, and monthly payment amount.