The Five C’s of Credit: Collateral & The Application Process
In today’s post we tackle the fifth and final C of Credit: Collateral. If you haven’t had a chance to read the first four posts make sure that you do, it’s important to understand how the five components fit together. We’ll also provide insight into how the credit application works on the bank side. Many people who go into a bank assume that it’s that particular office that is deciding whether to approve your application, but that’s not actually the case.
The term collateral can be used in many different ways and as a result it has a different meaning to everyone. Some people may recall the excellent film of the same name with Jamie Foxx and Tom Cruise, others may think of pawn shops and backroom lending.
For the purpose of a credit application, collateral is simply a fixed asset that is being used to secure a loan. This can be something small, like $1,000 locked in a GIC to secure a credit card for a non-resident of Canada, or something much larger like using your house to secure a mortgage.
This is something that will be taken care of by your bank, but there are some things to keep in mind. First, you need to have title to the asset before you can use it as your collateral, so make sure your name is on title for any property you plan to mortgage. Second, the major banks won’t take any asset as collateral that already has a lien on it from another lender.
The purpose of taking collateral is to hedge against the risk of you defaulting on your payment obligations. Simply put, if you become delinquent the bank can sell the collateral and repay itself. This is known as foreclosure, and it is really only utilized in worst case scenarios.
Now that you understand the 5 C’s of Credit and what your banker will be evaluating, it’s time to learn what they do with that information. Different banks take different approaches to approving people for credit.
Some banks give their branch employees predetermined lending authorities, which allows them to approve clients on the spot. Others give zero authority to their branch employees and force them to get everything approved by a credit adjudicator.
In almost all situations, banks require employees to get mortgages adjudicated because they are lending tremendous amounts of money and it’s critically important that all the documents be filled out correctly.
Credit adjudicators typically work out of massive office parks and have zero interaction with bank clients. Their job is to be meticulous with all applications and make sure they are filled out properly. Furthermore, they read the notes on the 5 C’s of Credit provided by the branch and make sure that the client is qualified for that product based on their previous financial history.
A good analogy here is that you are a client and your banker is your lawyer. You need to give your lawyer the best information you can so they can build a case on your behalf. They will then present that case to the credit adjudicator, similar to a judge, and that adjudicator will decide whether to approve or decline your application based on the facts.