The 4 C’s: Top Things Mortgage Lenders Use to Evaluate Your Credit
Buying a home is a big financial commitment. As such, most buyers obtain a mortgage to borrow money in order to buy a home. Understanding what mortgage lenders will look at in your finances, can help you plan and budget accordingly. Lenders value “Good credit” meaning you are considered low risk. The lower you are as a risk, the better (aka lower) your interest rate. Low interest rates can save you a lot of money. This is even more important as interest rates rise, and reducing your interest rate through good credit can be extra valuable.
There are four key factors, known as the “Four C's,” that determine what type of credit risk you are as a buyer:
#1 - Capital
Capital is the cash you have right now that you can use towards the upfront costs of a home. This helps assure lenders that you have saved money, and are less of a risk. Some of the capital can come from a gift, grant or special program. It is important though, that you have this documented prior to applying for your loan. Upfront costs include the following:
The more you are able to put towards your down payment, the less you will need to borrow. This will lower your monthly mortgage payments as well.
Lenders will verify the source of your down payment and your history of savings.
Bluebid Tip: If someone plans to give you the down payment (or a portion of it), make sure they sign a gift letter. This will inform the lender that the gifter has the money to give you, and are committed to doing so.
You don’t necessarily need 20% down to qualify for a mortgage. There are special mortgage products that require down payments of as little as 3% of the purchase price. However, as noted above, the less you pay as a down payment the larger your loan and subsequent monthly mortgage payments. You will also pay more in overall interest, since you are borrowing more money.
Closing costs include administrative fees and other charges related to your home purchase that are paid at closing. They’re normally 3% to 6% of the loan amount. Often buyers neglect to budget for closing cost expenses and are caught off guard by these fees. the lender will often let you finance the closing costs. However, when doing so, you will also be paying interest on this sum.
Moving costs can add up quickly. In addition to a truck rental, packing materials, etc., you often need to put down deposits for utilities and home insurance.
This is not an explicit upfront cost. However, lenders are reassured if you have a few months of mortgage payments saved, after your upfront expenses have been paid. This way If you have an unanticipated gap in your income or an unexpected expense, your mortgage payments will not be immediately at risk.
#2 - Capacity
Capacity is your monthly income and its stability. Lenders review your income, employment history, and earning potential. The general standard for stable income is two years with the same employer or in the same field. Lenders will require additional documentation if your income varies a lot, in order to demonstrate you will consistently be able to pay your mortgage.
#3 - Credit History
Your credit history is reflected in your credit score, which is key to qualifying for a mortgage. This provides a lender with empirical data that shows that you don’t spend more than you earn, use credit in moderation, and pay bills regularly and promptly. Lenders typically require 12 to 18 months of positive history: modest balances, no late or missed payments, etc.
#4 - Collateral
This refers to your future home. Lenders have the right to take possession of your home if you default on your mortgage. Therefore, they order an appraisal of the property to get an accurate assessment of what it’s worth. It must be worth at least as much as the loan amount. Your collateral is the officially appraised value of the home.