You will get all A’s if you know these C’s – Greenville Daily Reflector

I am often asked by my students, What is the single most important thing to focus on in managing my finances?

The first thing I tell them is its all important. All aspects of their finances are related to each other. I tell them that you cant separate your financial life from your personal life. Decisions made in one area can have an impact on another area. One of the keys to financial success lies in understanding the crossover impact a decision has into the other areas.

One area that most people seem to overlook is their credit rating. Credit touches all other aspects of your financial health. Excellent credit can go a long way toward making your financial dreams a reality. Poor credit can act as a lead weight around your neck and curtail your ability to achieve your financial goals and financial independence.

This statement is quickly followed with another question, If my credit is so important, how is my credit evaluated by others? Creditors follow what are called the five Cs of credit: character, capacity, capital, collateral and conditions.

Character has to do with your willingness to pay your bills on time. Your credit history is the key here. Late payments may be an indication that you are not as serious about your financial obligations as you should be. Most creditors wont report a late payment until it is more than 30 days late. Any late payments red flag lenders and could impede your ability to get the loan or increase the rate that you have to pay.

Capacity deals with your ability to pay the loan. Do you have the financial resources to pay the loan when it is due? Typically, this comes from your income. Lenders usually do not like to see your debt payments (home, car, credit cards and other loans) exceed roughly 36% of your gross monthly income (your income before anything like taxes is taken out). A debt payment ratio in excess of roughly 36% may be a sign that you wont have the resources to pay the loan on time even though you may have the desire.

Capital looks at what your assets (the things that you own) are and your net worth, the difference between what you own and what you owe. In looking at your assets the creditor is trying to see what if anything you could sell in order to satisfy the loan in a worst case scenario. Closely related to this, your net worth helps the creditor understand if over time you are moving in the right financial direction. A negative net worth is not necessarily a bad thing. It depends on the circumstances. A college graduate at age 22 who has a negative net worth of $35K from student loans is in much better shape than a 45-year-old with a small positive net worth.

Collateral is something that you own of value that is pledged to the lender that can be taken away by the lender and sold to satisfy the debt if you dont pay the loan. You can typically receive better loan terms when you provide collateral like the deed to your house or the title to your car.

Conditions take into account the big picture. What economic conditions, typically beyond your control, could affect your ability to repay the loan? Are you working in an industry that is currently downsizing? Did you leave your last job of 10 years to go to work for a dot com company? Do you move or change jobs frequently?

All of these factors are considered together when a creditor assesses the risk of your loan request. The weaker the five Cs are overall, the greater the risk. There is a direct relationship between risk and return. The higher the risk the more a lender is going to charge you to compensate for being exposed to that risk. Instead of getting that $25K car loan at 6%, you may have to pay 10%. On a five-year loan that would roughly cost you an extra $1,670 in interest expense. Placed in your retirement account for 30 years that extra $1,670 could grow to approximately $29,000. Now imagine paying a higher rate on all of your loans throughout your entire lifetime. People who take a casual attitude toward their finances dont realize that the cost of failing to maintain their five Cs is much higher than they ever could have imagined.

Mark C. Weitzelteaches in the Department of Finance in ECUs College of Business. Your Financial Health is provided by the department.

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You will get all A's if you know these C's - Greenville Daily Reflector