When it comes to borrowing money, we’ve come a long way from just a handshake to seal the deal. Now there’s an application process which includes meeting the qualifying guidelines, review and understanding of any terms and conditions, paperwork to sign and more that goes along with getting approved for financing.
If you’re wondering how it is determined whether a specific borrower is eligible to borrow money, how much they can borrow, and how you know if they qualify for lowest rates, than this is the article for you. Most lenders use the “5 C’s of credit” to determine the strength of a borrowers application and the stronger your application is, the more likely you will be approved for any type of financing. This week I want to briefly outline the most important aspects of a mortgage application and how you can determine how you look to a lender on paper.
Credit
One of the most important and most talked about components of any financing application is your credit. When you’re applying for credit, your potential future lender will want to know how you have paid your debts in the past and how much debt you have in comparison to the limits available to you. Your credit report will also show how long you’ve had credit, if you’ve missed any payments or if you’ve had any loans or debts go to collection. Most importantly, your credit report details are all tallied up to determine a final credit score that represents your overall credit habits. That credit score is critical to a lenders decision as they rely on it to determine the chances of you repaying the debt they have lent to you.
A very strong credit report shows at least 2 years history of repayment habits on at least 2 debts such as a credit card, car payment or a line of credit. There should also be no late payments, collections or judgments showing up on your credit report. Credit score wise, lenders like to see at least a minimum 650 credit score in order for it to be considered ‘good’. If you have some hiccups on your credit report, that may still be okay if the other “4 C’s” below are strong.
Capacity
Capacity is the borrowers ability to repay the loan. When applying for a new mortgage, these are the details of your income and employment. There are many different types of employment income that are acceptable to include in qualifying. These would be salaried earnings, hourly wages, commission, self-employment income and many more types as long as it is going to continue being earned in the future. What determines whether the capacity is strong or not is how much of your income the new mortgage payment and other applicable carrying costs is going to take up each month. Your potential lender will ensure your new loan is affordable for you so you are less likely to default and miss payments. If you are applying for credit that is unaffordable, you run the risk of getting declined due to lack of capacity to repay.
Capital
This ‘C’ also stands for cash, how much cash does the borrower have. Capital includes potential downpayment a borrower may have as well as the borrowers net worth (assets less any debts). These figures are important to the lender to determine what kind of initial investment into the property you are making as well as to demonstrate you will have additional savings available after you complete the purchase of the home. The presence of a positive capital position demonstrates to the lender the borrower will likely be able to support their mortgage payments as well as afford the other costs that come along with home ownership.
Character
There isn’t a minimum score or specific dollar amount required when it comes to this category. Character represents what kind of overall impression you and your credit application make to both the mortgage professional you’re working with and the potential lender you will be obtaining financing with.
Collateral
When it comes to mortgage financing, the collateral is the land and/or property used to secure the loan. Meaning if you don’t make the payments on your mortgage, the lender will take the property away from you in order to sell it and pay off the mortgage financing you owe them. For this reason, lenders take into account the characteristics of the property the borrower is trying to finance. If you’re looking for best rates, you will be expected to have both a strong mortgage application and a desirable property for financing. Desirable property being one with no features that would deter some buyers in the event the lender has to resell the property.
There are of course other components of the mortgage process that determine the borrowers eligibility for mortgage financing, though I find the “5 C’s of Credit” are basic building blocks we use to determine how the mortgage application should be structured in order to secure the highest chance of approval from a mortgage lender. It is critical you are honest and forthcoming with your information in the preliminary application process to ensure your mortgage professional has all the pertinent details they need to find a mortgage solution that meets your mortgage needs and one that you can qualify for.