4 C's of Mortgage Lending
June 10th, 2009
Categories:Home Buyer Education
Although specific guidelines can vary from one loan program to another, there are four basic principles evaluated for each homebuyer. These are referred to as
the 4C’s of mortgage lending: Capacity, Capital, Credit and Collateral.
Capacity -
The ability to repay your loan based on your employment and income history. Your lender will look at the amount and stability of your income. Housing costs including property taxes, homeowners insurance, mortgage insurance in some cases and homeowners association dues should be approximately 29% of your gross income.
Types of income that are considered will include:
- Hourly or salary wages
- Commissions, overtime or bonus income
- Self employment income
- Social Security/Retirement/Disability Income
- Notes receivable/interest income
- Income from rental property
- Child support or alimony
A two year history of these incomes in considered acceptable. It is important to mention that incomes such as commissions, overtime or bonus must be averaged to allow for fluctuations in these incomes. In order to consider other income such as notes receivables, child support, alimony, one must be able to document that these incomes will continue for at least three more years.
Capital -
The amount of money you have saved to cover your down payment, closing costs and cash reserves as required by your loan program of choice.
Acceptable sources of funds that will be considered:
- Bank accounts such as checking/savings/money market/cd’s
- 401K
- Stocks/Bonds
- Equity from sale of your present home
- Gifts from family members or other acceptable down payment programs
Credit -
Your credit report will be reviewed to determine the amount of outstanding credit you currently have and the quality of your credit. Your past credit history is a good predictor of how you will handle your future obligations. Your overall history will be reviewed but the past two years will be a greater indicator of your ability to repay.
Credit scores are also a strong indicator of your credit history. There are three national companies that each provide a credit score: Experian, Equifax and Transunion. These scores are affected by the amount of accounts you have open, the length of time these accounts have been open, outstanding balances, collections, judgements and inquires for new credit. It is important to review this information early in your home buying process as this may affect your ability to purchase a home. You may also find that items have been reported in error on your credit report and this will allow you the time to “repair” your credit.
In some cases, a delinquent credit history does not mean that you will not be able to purchase a home. Lenders are looking for patterns. Perhaps you paid on time and suffered some trouble which caused some late payments but now you are back on track, you may qualify for a loan depending on the circumstances and the severity of the delinquent credit. Should you have filed foreclosure or bankruptcy, you will need to wait two to three years and reestablish good credit prior to purchasing a new home.
Collateral -
The lender will want to determine if the home you are purchasing is good collateral for the loan by securing an appraisal on the property. The appraisal is used to determine whether or not the property could be sold to satisfy the note should you default on the loan.
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