Most lenders consider these four vital factors before giving you a residential home loan.
The Four “C”s
Why are these four factors important?
- Collateral (Loan to Value ratio)
Your mortgage will typically be a proportion of the value of the real estate. For example: the home has a market value of $100,000 and you want to borrow $80,000 as a first mortgage. This would be a Loan to Value ratio of 80%.
Let us assume for the moment that you are buying the house for full market value, that is $100,000. Where does the rest of the money come from, $20,000 plus the closing costs, pre-paids etc? It could come from your savings, it could come from a second mortgage, either a seller held second mortgage or another lender, it could come from a gift, perhaps from your parents. Or it could be a combination of these.
Lenders LIKE you to have your own money in the deal. If the other 20% is your money, this gives them a strong feeling of security.
How about if you are actually buying this $100,000 house for $70,000? Conventional lenders like banks will only lend you 80% of the market value or purchase price, whichever is LOWER. In this case they would lend you 80% of $70,000, or $56,000
Why is this? It makes the loan safer for them, they don’t really believe that you have got a great deal and they still want you to have your money in the deal.
Why is the Loan to Value ratio important? Simple. If the lender has to foreclose on the loan because the borrower hasn’t paid, they will not only want to recover the principal outstanding, but also their legal fees and unpaid interest. Obviously this can only happen if the house is worth more than the principal, legal fees and accrued interest. If they lent $100,000 against a home worth $100,000 this is not likely to be the case!
- Credit
If you have a proven history of not paying other people on time, it is highly likely you won’t pay the lender on time. Let’s be blunt here. When someone has bad credit, what it really means is they just don’t pay their bills. Now there can be a good reason for this, and these are often taken into account. For example medical bills when someone has no health insurance. Or perhaps you went through a nasty divorce and your bank account was cleaned out. Maybe you started a business that failed and have now got a regular job.
But if there is a track record of car repossessions, credit card write-offs, unpaid utility bills etc. you come across as someone who is financially irresponsible. Unless the property is worth a lot more than the loan you want, you probably won’t get it.
- Capacity
The lender wants to sure that you can afford to pay your mortgage and still pay your other bills. In fact, it is LAW in some states that lenders avoid residential loans that the borrower clearly can’t afford. They will consider your job history and your time on job. How much other debt do you have? Are you over extended? Conventional lenders use certain ratios to calculate your capacity to pay back the loan.
- Commitment
Commitment is usually shown by having your own money at risk. If you are buying a $100,000 home and put down an investment yourself of $20,000 you have made a big commitment and will not lightly walk away from your obligations. On the other hand, if you have none or little of your own money invested, you are much more likely to just shrug your shoulders if things get tough and walk away from your obligations. Consistently, year after year, low down payment FHA mortgages loans have a higher default rate than conventional mortgage loans.
- How important is my credit score?
Credit scoring has an enormous impact on a borrower’s ability to purchase a home. It can mean the difference between getting a good interest rate and the home of their dreams, or whether they even qualify for a conventional loan at all. For this reason, it is important to understand the credit scoring process, and find out your credit score is when you begin to look at obtaining mortgage financing. Mortgage lending is very competitive business and many options still remain for borrowers with lower credit scores. Please call me with any questions or help in pre-qualifying for a home mortgage.
