How do banks make credit decisions?

Written by: Michael Mims, Managing Director, Private banking

Banks are generally on the conservative end of the lending spectrum.  Clients deposit funds into banks for safekeeping, to transact business, and earn a reasonable rate of interest on their funds.  Banks lend these funds out at a spread over their cost of holding the deposits.  This is the primary source of revenue for most banks.  Since Banks are lending client funds, they require reasonable assurance that borrowing clients can repay their loans.  This is considered the five C’s of credit:

Character – Banks will look at a potential borrower’s credit history to evaluate their past track record in managing their finances and credit repayment history.

Capacity to Repay – Banks look at your average historical recurring income and recurring debts to determine a client’s debt to income (DTI) ratio.  New borrowers may not have this historical income information and banks will generally rely on recent paystubs, employment letters, etc. to determine a DTI.

Collateral – Will the credit facility be secured by tangible property (i.e. home, vehicle, equipment, inventory, etc.)? Generally, loans secured by collateral are considered less risky.  Unsecured loans are considered riskier and require borrowers to demonstrate a greater level of capacity to repay.

Capital – Capital is how much money the borrower has to put down on a loan request (investment in the collateral property for the loan). This again could be the down payment on a home, vehicle, equipment, inventory, etc.

Conditions – What are the terms of the credit facility (i.e. interest rate, principal amount, repayment term requested, etc.)?  Banks may also consider economic conditions, industry, or any pending legislation that could affect repayment.

Other factors banks may consider are:

  • Are there personal guarantees that add additional financial strength to the credit request?
  • Is there a secondary (backup) source of repayment?


What is considered my obligation?

Everything on a credit report is your obligation.  A credit report usually consists of the following:

  • Mortgage Payments
  • Auto Loans
  • Credit Card Minimum Payments
  • Collections/Medical Collections


What is not on a credit report?

  • Rent
  • Child Support
  • Alimony
  • Taxes Due


Click here for more information on understanding credit reports.