Howard Dyal, President, Principal Broker, Prodigy Home Loans
Many would-be homebuyers have sustained chinks in their credit profile over the last few years and may view their less-than-perfect-credit score as an impenetrable wall that separates them from their dream home. While credit score is important, it is not the only consideration. Below are the “Four Cs” lenders evaluate to determine your credit worthiness.
1. Credit History
Credit history is a collection of information, including credit score, about a person’s past behavior in managing debt. How a borrower handles financial obligations -especially during periods of adversity- is a significant indicator of character or credit reputation. How have you managed credit in the past? Have you repaid debts as agreed? Do you have a history of timely rent, utility and other debt payments? Are there contributing circumstances surrounding a late payment? Lenders will seek to answer these questions. The higher the score, the less risk to the lender and typically the lower the interest rate on the loan.
Collateral is a pledge of property or other assets that an individual uses as security against borrowed monies. In the case of a home purchase, the lender will require an appraisal to determine if, based on its market value and condition, the property has sufficient value to be used as collateral.
The relationship between the amount of the loan and the value of the home is called the loan-to-value ratio (LTV) and is expressed as a percentage. The higher the ratio, the more risk to the lender and typically the higher the interest rate on the loan. Committing to a larger down payment may shift this ratio in your favor.
Capacity pertains to the borrower’s ability to repay the loan. It is calculated by weighing the borrower’s income, including the likelihood of continued earnings ability, against the amount of debt now carried plus the proposed house payment. This is generally referred to as your debt-to-income ratio. Do you have a steady job? How long have you worked in your current field? Is it likely to continue? How much do you already owe? In figuring capacity, the underwriter must determine how much total financed debt the borrower’s budget can reasonably handle.
Capital is the borrower’s cash to close plus reserves. Capital is not expected to be a means of payment, but it reassures the lender that you have resources, other than monthly income, to repay debt if a job loss or period of adversity occurs. Lenders only consider cash reserves and other assets that are of tangible value at the time the application is being processed.
Understanding how lenders determine your income and credit profile can help you be better prepared to present your financial situation in the best light so that you not only secure a mortgage but also do so with more favorable terms. It also may be reassuring to know that lenient loan products have recently been introduced to help people with past financial issues that were beyond their control. Contacting a licensed loan professional for pre-qualification can help you determine what your credit and income profile reflects and what lending options may be available for you.