Commercial Lender approval criteria-4 C's

The World of Commercial Lenders may seem complicated at first but it's quite simple. The lender is primarily looking at 4 things: Character (Are they willing to pay us back?), Capacity (Do they have the ability to pay us back?), Capital (Do they have a sufficient amount of cash to insure we get paid?), Collateral (In the event of default, is there enough value in the collateral that once it sells, the loan gets paid off?)

Most Commercial Banks and Credit Unions are Historical Cash Flow Lenders which means they focus on cash flow for repayment. The last thing they want to look at for repayment is the collateral. They are not in the business of selling properties. This is why they're focused on the 4 C's of Credit with the first 3 being the most important.

Different from Commercial Banks and Credit Unions, Hard Money Lenders are focused on the collateral and pay less attention to the cash flow. This is why their rates are significantly higher and typically used for short term situations.

Here are the 4 C's of Credit:

Character:

Of the 4 C's of Credit, Character is the most important thing that lenders base their decision on. Lenders typically base character from reviewing your credit report/credit score.  In addition, they may also do a background search to see if there has been any criminal history or lawsuits. If there have been any recent or pending lawsuits, recent criminal charges, a past bankruptcy, or anything derogatory on your credit report, it is very important that you indicate these items upfront before a lender finds them in your past. When a client is upfront about these items and they provide an upfront explanation, it is easier for the lender to get comfortable with you as a client. If they find out something later down the road that was not disclosed upfront, it is more likely they will pass or decline your loan. From a lender's point of view, it is Character above all that lenders rely on to get paid back.

Capacity:

Capacity determines your ability to repay the loan.  This refers to the cash/cash flow that is generated by your business after expenses are paid that can be used to make loan payments. In addition, they make also look at your outside income sources and other income sources to figure out your repayment ability. The Lender will do a Debt Service Coverage Analysis to make sure the property or business generates enough cash to cover the payments, typically at a 1.25: 1 or higher coverage basis.

Capital:

Capital can refer to cash or other assets.  If you put a large amount of cash down on a property or business, it reduces the risk to the lender of getting paid back. In addition, if you have a large amount of cash sitting in your business or personal accounts, it makes the lender more comfortable that you'll be able to make the payments if your business's cash flow drops for some reason or if a tenant moves out and you lose income for a period of time. Also, if most of your business's assets are paid for or you have other properties with little to no debt, you're able to possibly leverage these assets for additional capital if needed which may also help in the lender's decision.

Collateral: 

Collateral is what you pledge to secure the loan whether it's real estate, inventory, receivables, securities, equipment, etc. A loan that is secured by Collateral typically have lower interest rates verses an unsecured loan. Also, Collateral is the last form of repayment to the lender in the event of default (Non-repayment or something else) and lenders typically want to avoid selling a business's assets or a property in order to get paid back. In addition, there are legal costs and other expenses associated with this. This is the reason that lenders focus more on the initial 3 C's before they get to this one. 

Again, Lenders focus on Character first, then Capacity and Capital, then on Collateral. There are exceptions to this such as hard money lenders which focus more on the collateral but they also charge significantly higher rates due to this. If you have any questions, please contact me.