In the late 1800s and early 1900s, America was a booming economy with millions of immigrants arriving from all over the world. These people would go on to help establish small towns all over the United States, but establishing towns requires a great deal of investment. In order to facilitate economic growth and trade, local banks made loans to people to help them start businesses, build homes, and purchase land.
Official records of financial history were scarce and things like credit helpers didn’t exist, but banks still needed to decide how much to loan to whom. This leads us to ‘character,’ the first of the three Cs of credit–character, capacity, and collateral.
Character
Character, in this context can be boiled down to a simple question–can the bank trust you? In the old days, a banker typically had to know you personally in order to approve a loan for you. In the case of someone who wasn’t known to the bank, they may have required witnesses to attest to their personal character and trustworthiness.
If a person couldn’t get anyone to vouch for them, the loan was quickly denied. You had to make sure your neighbors liked you, because those of ill repute simply couldn’t get a loan. Tips on repairing your credit amounted to being told to get yourself together and become a functioning member of society.
Capacity
This isn’t a measure of how much your wallet can hold–capacity, in the context of credit, is the ability to repay the loan. How much money do you make, and what is your job? To go back to our small town example, banks would be hesitant to loan money to anyone who didn’t live in the city or lacked steady employment.
Beyond making sure you had a steady job and income, the bank would also look at the loan amount you were asking for. If you only made $40 a month and the loan payment was $25, banks would be hesitant to lend you money, as it would be likely that if an unexpected expense came up, you’d have trouble paying your bills.
Collateral
Collateral is a rather simple concept–the bank wants a way to recover their money in case you stop paying your bills. Typically, this means writing a clause in the loan contract that if you are unable to pay, the bank has the right to seize your property and sell it to recover their money.
One’s property is collateral for their loan. This can be anything from land and real estate to vehicles and other valuables.
The Three Cs Today
Today, the first and second Cs are easily assessed by looking at a person’s credit report. A credit report clearly states how many loans you have outstanding and what their payments are. It also shows if you pay your debts on time and if you miss payments frequently or not at all.
The last C, collateral, is still used today, separately from the credit report. In the case of auto and home loans, the bank owns the title to a car or house until it’s paid off, and it has the right to seize the property should you stop making payments. In this way, the house and car are the collateral.
Those asking for large personal loans will still be asked to provide collateral if the lender has suspicions about ability to repay. Collateral is also one way a person can obtain a credit card with bad credit–although, it may not be in the way you think. Check out our latest post to learn more!