Buying a home can be a real challenge. Usually, you will look at many homes before finding “the one” that’s right for you. Then, it’s time to find a mortgage.
Your job is to convince a mortgage banker that you are a good investment. You meet with the lender(s), bringing praise about yourself and the house that you want to buy. You hope they will decide you are worth the risk as much as you believe you are worthy of being provided the necessary funding so that you could own your own “dream home.”
When the lender reviews your application, they are looking for your ability to pay off your loan. After all, the lender is taking a chance on you, and their goal is to reduce their risk as much as possible. Let’s look at the primary factors a lender takes into account when you apply for a mortgage. The better you do score on the “Five Cs,” the more likely they are to say yes and have you signing on the dotted line.
Your credit history
The first thing the lender will do is have a look at your credit report and credit score. There are three components on your credit report that the lender will look at.
- Payment history. If you have missed a number of payments and/or let accounts become delinquent, the lender will likely not see you as someone they can depend on to handle a large mortgage payment month after month for years to come.
- Age of credit history. Do not jeopardize the age of your credit by opening a new account shortly before you apply for a mortgage. A lender may wonder why you needed more credit suddenly.
- Debt to Income Ratio. This is an important factor, because the lower your debt is in relation to your total gross income, the more confident your lender is going to be that you can add a mortgage payment to your debt load comfortably.
Your capacity is your financial ability to pay a mortgage. Having a good job for a few months isn’t enough. The lender usually wants to be able to verify at least two years of employment. They want to see your work history – how long you have stayed at one company, and that you have a stable source of income. If you leave a company, to the lender this is reason for concern, unless it’s because you got a position that pays more in the same profession. Making a career change actually makes you more of a risk. A lender has no way of knowing if your job as a chef at a new organic restaurant will be as successful as your 8-year stint as a computer programmer was.
If you own your own business or your career is unconventional, you will need to be ready to provide your tax returns and to answer a number of questions. The kind of income you make is also judged. If you have a guaranteed a paycheck every month, that’s rated highly. However, bonuses and commissions can come and go, and that can make you appear less dependable.
Conditions are one of the C’s that you have no control over because it refers to the state of the economy and the local housing market where you plan on buying. Lenders may also want to know what your reason is for buying this home. Renting out a home will generate you significantly more income than if you plan on living in it full-time. Lenders will look at the outside influences and how these influences could affect the property’s value and your ability to pay the loan off.
When you have a significant amount of money in the bank, it makes you more appealing to the lender. They want to see that your assets are liquid, which means sitting in your savings accounts, so that you can easily access money to pay your mortgage if the need arises. Retirement accounts and investment accounts also count as assets, even if you can’t access them as easily. It’s wise to grow these savings over a period of time. This will confirm that you have been growing and building your cash reinforcements, and that you didn’t just make a one-time deposit thanks to a generous gift from your parents that makes you look good.
Collateral is the assets lenders can cease if you can’t make your mortgage payments. In the case of a mortgage, it is the house that is the collateral, so they want to make sure that the value of the house covers the mortgage should you default. The appraisal tells the mortgage company what is the value of the property you are looking to buy. Collateral helps reduce the lender’s risks.
When the lender receives your mortgage application, they have to decide whether they want to put their neck on the line for you. The process is tough, and lenders are going to try to determine all the potential risks. At the end of the day, it is really about fiscal responsibility. If your score on the Five C’s is good, you will soon be enjoying that white picket fence and your dream home.