This lesson examines the techniques used to assess a consumer borrower’s creditworthiness, emphasizing the “5 Cs of Credit” framework, credit scoring, and income verification.

6.1 The 5 Cs of Credit
The 5 Cs of Credit framework is a foundational tool for evaluating consumer and business borrowers. A comprehensive credit analysis will address each of these areas:

  • Character: The borrower’s willingness to repay, assessed through credit history, references, and stability.

  • Capacity: The borrower’s ability to repay, determined by analyzing income, expenses, and debt-to-income ratio.

  • Capital: The borrower’s net worth and financial reserves.

  • Collateral: Assets pledged to secure the loan, which can be liquidated in the event of default.

  • Conditions: The purpose of the loan and broader economic factors that could affect repayment .

6.2 Credit Scoring and Credit Reports
Credit scoring models, such as the FICO score, are widely used to assess a consumer’s credit risk. The process of evaluating credit risk and the use of credit scoring is a core component of consumer lending education . Lenders must know how to:

  • Analyze Credit Reports: Understand the three main sections: personal information, credit history, and public records .

  • Interpret Credit Scores: Understand the factors that influence the score, such as payment history and debt utilization .

  • Handle Credit Reporting: Ensure compliance with the FCRA regarding the use and accuracy of credit information.

6.3 Income Verification and Documentation
Verifying income is a critical step in the consumer loan process. Lenders must have clear policies and procedures for documenting income, with requirements varying by employment type:

  • Salaried Employees: Often verified through recent pay stubs and employment verification.

  • Self-Employed Applicants: Require more extensive documentation, such as personal and business tax returns (Form 1040, 1065, 1120) , and may require the calculation of income using specific underwriting guidelines .

  • Other Income Sources: Including rental income, investment income, and government benefits. Best practices for reviewing supporting documents apply to all forms of income verification .

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