Am I Eligible for a Credit Card or Mortgage?

Debt is a key component of your finances, whether that be using a credit card to build a solid lending history, or having a mortgage assist you in owning real estate. But before you start using credit, you should be aware of the adjudication process of credit approval:

The process for determining your eligibility for receiving credit is commonly known as The 6 C’s.

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The 6 C’s of Credit Adjudication

When applying for mortgages, credit cards, lines of credit, or loans of any kind, lenders evaluate the qualities of the individual borrower. Knowing what institutions look for in a credit application can help you best position yourself to get that approval. When you apply for credit, you are evaluated based on the following: Capacity, Credit, Capital, Character, Collateral, and Conditions.

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1. Capacity: Ability to Pay Your Debts

The first quality in a credit application is known as Capacity: an individual’s ability to make the required payments for their debts. Simply put, lending institutions may use different forms of debt-income ratio calculations, all of which compare the amount of your current debt repayments to your total, gross income*. It’s best to keep your debt levels manageable and to be sure that you can make all necessary payments on time. If your debt-income ratio is deemed healthy, or permissible, by the lender, they will then evaluate the health of your second C: Credit.

* Gross income is the total amount of money earned in a given period of time. This is different from net income, which is the cash left over after taxes.

Debt-income ratio calculations are used to compare the amount of debt you owe to your income, which evaluates whether you will be able to make payments on time.

2. Credit: Previous Willingness to Repay

In your credit application, a crucial component of getting approved may be Credit: an individual’s previous willingness to repay debts as agreed upon. Most institutions will look at the potential borrower’s credit bureau report, which is a document that contains detailed information about the applicant as well as their previous credit usage. Here, institutions look at the types of debt someone currently has, the length someone has had their current debts, the consistency of on-time debt repayments, and so on. Paying off your debts, in full and on time, is very helpful in your process of obtaining those mortgages, credit cards, and other loans. If this aspect of your application is satisfied, institutions may look at your Capital.

Institutions look at your previous credit usage, the type of debt you’ve had in the past, how long you’ve had your current debt, and how consistent you’ve been with repaying your debts on time.

3. Capital: Specifics of Net Worth

Lending institutions may turn their interest to analyzing your available Capital: an individual’s value and characteristics of their current net worth. Net worth is the measure of one’s financial health. The calculation is quite simple:

Net Worth = Assets – Liabilities*

Not only will institutions evaluate the value of your net worth, but also the specific qualities of your assets and liabilities. Having more liquid** and non-volatile assets like savings accounts and GICs*** can help someone’s application. Investments, such as those in stocks, bonds, and mutual funds, also help someone’s Capital component of their application, but not significantly as their future values are uncertain. And finally, illiquid assets like real estate and vehicles may not improve the Capital component because they cannot easily be sold to pay off outstanding debts. If someone has sufficient qualifications for the Capital aspect of their application, institutions may look at the applicant’s Character.

* Liabilities are another word for debts.

** Can be easily converted into cash.

*** Guaranteed Investment Certificates.

Having more liquid assets, which are easily converted into cash, show institutions that you are able to pay off your outstanding debts.

4. Character: The Actual Person

While much of the credit application focuses on financial information, a key component of the process reviews the applicant’s Character: an individual’s employment history, education history, and overall money management. Many institutions may prioritize being employed long-term in one or a few occupations, having a diploma or other types of education certificates, and utilizing sustainable saving and spending habits. Even slight changes to your budgeting (maybe not eating out as often, or impulse buying) may help your process along to get approved for credit! For certain types of loans, lenders may also look at someone’s availableCollateral.

The applicant’s employment history, education history, and overall money management is looked at.

5. Collateral: Pledged Assets

For some types of credit, someone may help the process along by pledging Collateral: an individual’s asset that, if the debt cannot be repaid, can be liquidated by the lending institution. Common collateral may be vehicles, houses, other types of investment, as well as cash. With some types of credit, the pledging of collateral may not be permissible, so, of course, contact your lending institution before you apply. After the decision whether to pledge collateral or not has been made, lenders may finally consider the current economic trends and Conditions.

Lenders have more confidence in giving you credit if you place some assets as collateral, like a vehicle, house, or cash.

6. Conditions: The Economy

The last part of having someone approved for a loan relies on the Conditions: the current and future economic outlook. If, for instance, the world was in the midst of a global pandemic, different considerations may have to be made in comparison to other periods of time. If the lender says that they are willing to give loans during certain economic times, then the process of credit application is now completed.

If lenders are more optimistic about the economy, they may be more lenient in their decision to give out credit.

Will I Be Approved for a Loan?

Whenever considering applying for a mortgage, credit card, or other types of loans, remember the 6 C’s: Capacity, Credit, Capital, Character, Collateral, and Conditions. Although approval is never guaranteed, you build a healthy financial situation as soon as possible, and welcome debt (when used appropriately) into your journey. About 40% of Canadians have a mortgage, and if you want to own property or purchase valuable items, then positioning yourself well for your credit application may be one of the best decisions you’ll ever make.