Maybe you’ve been busy saving money to buy your first home. Or maybe you are just dabbling with the idea of purchasing your first home in the distant future. Either way, at some point you are going to have to secure a mortgage. Whether you are ready to start shopping for a mortgage or are just beginning to understand what this home-buying process entails, it will be beneficial to know exactly what lenders will be looking for. The answer lies in, you guessed it, the 4 C’s of credit! In this post, we’ll dissect exactly what each of the 4 C’s mean so that you can better understand how credit can help you get approved for a mortgage.
What are the 4 C’s of Credit?
Capital. Credit History. Capacity. Collateral: The infamous 4 C’s of credit. Lender’s review each of these concepts when determining whether or not you are a good candidate to lend a mortgage to. By investigating the 4 C’s mortgage lenders are better able to tell how reliable you are.
Why are the 4 C’s Important?
Each of these C’s will help you get in the minds of a mortgage lender and uncover exactly what they are looking for when considering to lend you a mortgage. Grasping these concepts may give you an upper hand because you have an opportunity to iron out any problems before you apply for a loan!
Diving Deeper
Now that you can successfully rattle off each of the 4 C’s, let’s dive into exactly what they mean and how they can apply to you!
Capital
Let’s start with capital. Capital is your own money that you are going to put towards your potential investment. It can be in the form of down payment, moving fees, and closing costs, including the money you have left over.
Lenders like to see that you are able to put down some of your own money towards this investment. It demonstrates to the lender that you are responsible enough to save and smart enough to manage your money. You are proving to the lender that you are indeed serious about buying this house! After you’ve already contributed your own hard-earned money, you are more likely to stick it out for the long run. In turn, lenders feel that they can rest easier knowing that you are going to repay every penny for your new home.
The more money you put down for your down payment, the lower your interest rate and monthly payment may be. In addition, if you put down at least 20% down for your down payment, you can dodge the additional purchase of something called Private Mortgage Insurance. It’s mandatory to purchase PMI with a down payment of less than 20%, but don’t worry, having to purchase PMI is not a bad thing! We will get more into that later on in this course.
Credit History
Another thing that mortgage lenders are going to look at when deciding whether or not you are a good risk is your credit history. By reviewing your credit history, lenders will be able to see just how well you are managing the debt that you currently have.
Are you consistently paying your bills on time? Are you earning enough each month to make your payments? Before adding another debt to your plate, mortgage lenders want to see that you are making strides towards being debt-free!
Capacity
Next, lenders are going to look at capacity. That is, how much money you earn compared to your recurring debt. Lenders want to see that you have enough money coming in each month in order to cover your current debts.
Proof may be requested by the lenders, such as income statements, tax returns, and history of employment. It’s important for lenders to verify whether or not you are reliable enough to take on a mortgage loan. These documents will provide verification to the lender that you do indeed have enough money coming in each month to pay back your loans.
Collateral
Obviously, a lender takes a huge risk when they decide to loan someone a mortgage. They want to be sure that, if they lend you a mortgage, you will pay it back; and not just pay it back, but also on time.
But what happens if a borrower can’t make their payments? Does the lender lose all of that money that they so-graciously lent the borrower? This is the purpose that collateral serves. It acts as a form of security for the lender that if the borrower were to default on their loan, they wouldn’t lose out on that huge sum of money! Collateral is an asset that the lender would gain possession of if the borrower does not make their payments.
In terms of a house, if a borrower defaults on their loans the mortgage lender gains possession of the house.
You may be wondering, how many payments can I miss before my home is foreclosed on?
Typically, the foreclosure process begins after the 4th month of missed payments. After 120 days, the mortgage servicer can issue the legal process of foreclosure. After 120 days, the mortgage servicer can issue the legal process of foreclosure.
It may sound scary to you, but it’s important to know that the lender doesn’t want you to default. They would rather not add on the burden of taking over the property. Collateral just ensures that the lender won’t lose their money if you were to default on your loan.
BONUS:
You may start seeing a 5th C, which stands for Character. Lenders assess potential borrowers character by judging their overall personality, reliability, and integrity.
Character is not one of the core 4 because it is subjective. But even so, it can still play a small role in your approval. One way to improve your lender’s overall impression of you is to build a positive relationship with the banker. The better the relationship, the more the lender will do to get your loan approved.
Takeaway
Now you know just what lenders are on the lookout for! By knowing the 4 C’s and what they mean you can get ahead of the mortgage-lending game. Whether you’re ready to mortgage shop tomorrow or you’re just looking to learn a little bit more about the home buying process, gaining insight on the 4 C’s of credit will be helpful to you.
