Getting a mortgage can be scary, whether you are buying a home for the first time or coming back to the market after a long break. By learning what lenders look at when deciding whether to make a loan, youll be more confident in navigating the mortgage application process.
Standards may differ from lender to lender, but there are four core components — the four Cs — that lenders will evaluate in determining whether they will make a loan: capacity, capital, collateral and credit.
The four C’s of credit are the four main things that lenders look at when they decide whether to give you a loan. If you know and understand these things, you can improve your chances of getting credit and get better loan terms. The four C’s are:
Capacity
Capacity refers to your ability to repay the loan. It is one of the most important factors lenders look at They want to make sure you have enough income left over after paying existing debts and expenses to comfortably make the new loan payment
To assess capacity, lenders look at
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Your income – Lenders verify your income, how long you’ve been employed in your current job, and whether your income is from a stable source. Self-employed income may get more scrutiny.
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Your debt-to-income ratio, or DTI, is the amount of monthly payments you have on your debts divided by the amount of money you make each month. Many lenders prefer a DTI of 38% or less.
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Your credit history – Lenders look at how much available credit you have and your track record of making payments on time. Too much outstanding credit card debt can negatively impact your DTI.
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Other debts like student loans, car loans, child support, and so on All your monthly expenses are considered.
Capital
Capital is your money or the amount of equity or down payment you’re putting down on a house. You have cash on hand in the form of savings accounts, stocks, bonds, and other assets that can be turned into cash if needed.
More capital and down payment lowers the loan-to-value ratio, which makes you less of a risk for the lender. It shows you’re invested in paying back the loan. Capital sources can include:
- Downpayment funds
- Savings and checking account balances
- Retirement accounts
- Investments
- Gifts from family
- Down payment assistance programs
Lenders typically ask for current statements to verify your capital. Large deposits or asset transfers may need documentation.
Collateral
Collateral is the asset being purchased that secures the loan. For a mortgage, it’s the home itself. For a car loan, it’s the vehicle. The lender can seize the collateral if you default on the loan.
Lenders look at the loan-to-value ratio, or LTV. This compares loan amount to the appraised collateral value. A higher LTV poses more risk for a lender, so most have a maximum LTV limit.
Providing collateral with stable value lowers risk. Borrowers with significant collateral may be able to qualify for more favorable loan terms.
Character
Character refers to your credit history and score, which lenders view as an indicator of how likely you are to repay debts responsibly. They will review:
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Credit reports from the three major credit bureaus – Experian, Equifax and TransUnion.
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FICO credit scores – The most commonly used credit scoring model ranges from 300-850, with 700+ considered good credit.
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Length and diversity of credit history – Having different types of accounts (credit cards, auto, mortgage) and a long history of managing them responsibly positively impacts your score.
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Negative marks – Late payments, collections, bankruptcies and other derogatory marks can negatively impact your credit profile.
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Credit inquiries – Too many hard inquiries from applying for credit in a short timeframe can slightly lower your score.
Knowing where you stand with the four C’s can help you understand what areas may need improvement before applying for credit. There are steps you can take to strengthen your credit profile in each area and put yourself in a better position to get approved.
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Capacity to Pay Back the Loan
Lenders look at your income, employment history, savings and monthly debt payments, and other financial obligations to make sure you have the means to comfortably take on a mortgage.
One of the ways lenders verify your income is by reviewing several years of your federal income tax returns and W-2’s, along with current pay stubs. They evaluate your income based on:
- The source and type of income (e.g., salaried, commission or self-employed).
- How long youve been receiving the income and whether its been stable.
- How long that income is expected to continue into the future.
Lenders will also look at your recurring monthly debts or liabilities, such as:
- Car payments
- Student loans
- Credit card payments
- Personal loans
- Child support
- Alimony
- Other debts that youre obligated to pay
Lenders consider your readily available money and savings plus investments, properties and other assets that you could access fairly quickly for cash.
Having money saved or in investments that you can easily convert to cash, known as cash reserves, proves that you can manage your finances and have funds, in addition to your income, to pay the mortgage. Cash reserves might include:
- Savings
- Money market funds
- Other investments that can be converted to cash, such as individual retirement accounts (IRAs), certificates of deposit (CDs), stocks, bonds or 401(k) accounts
Along with cash reserves, other acceptable sources of capital might include:
When you apply for a mortgage, the lender may need to verify the source of any large deposits in your bank account to ensure theyre coming from an allowable source. That is, that you obtained the money legally and that it was not loaned to you.
Lenders may also look at the last two months of statements for your checking and savings accounts, money market accounts, or investment accounts to evaluate how much capital you have.
Lenders consider the value of the property and other possessions that youre pledging as security against the loan.
In the case of a mortgage, the collateral is the home youre buying. If you dont pay your mortgage, the mortgage company could take possession of your home, known as foreclosure.
To determine the fair market value of the home youd like to buy, during the homebuying process your lender will order an appraisal of the property that compares it to similar homes in the neighborhood.
Lenders check your credit score and history to assess your record of paying bills and other debts on time.
Many mortgages also have minimum credit score requirements. In addition, your credit score could dictate the interest rate you get on your loan and how much of a down payment will be required.
Even if you are a renter, or dont have plans to buy right now, its a good idea to get smart about credit and know ways you can build and maintain strong credit health.
Learn more about how you can prepare financially for taking out a loan, including how a housing counselor can help.
What Are the “4 C’s” of Credit?
FAQ
What are credit 4 Cs?
When you apply, lenders evaluate the risk of lending you money by weighing four core key factors known as Credit 4 Cs: Character, Capacity, Capital, and Collateral. In this post, we’ll break down each factor to help you understand a banker’s mindset—and possibly increase the chances of hearing “yes” more often than “no. ”.
What are the 4 Cs of credit analysis?
The components of traditional credit analysis are known as the 4 Cs: Capacity: The ability of the borrower to make interest and principal payments on time. Character, capital, capacity, and collateral are the four Cs of creditworthiness. Use isn’t completely tied to any one of the four Cs of creditworthiness.
Why do the 4 Cs of credit matter?
The 4 Cs of credit are important because they show lenders how stable and trustworthy your finances are. Evaluating Character, Capacity, Capital, and Collateral helps them assess the risk of lending to you and decide on loan approval. Knowing these factors can improve your chances of securing financing. What is Capacity?.
What are the 4 C’s of a home loan?
While different lenders may have their own specific qualifications for securing a home loan, there are four main factors that they’ll review and analyze during the mortgage underwriting process. These main factors are credit, capacity, capital, and collateral. Let’s dive deeper into each of the four C’s of credit.
What does capacity mean in the 4 C’s of credit?
The four parts of traditional credit analysis are called the “4 Cs.” Capacity: The borrower’s ability to pay back the loan and interest on time. What are the 4 Cs of credit?.
What are the 4 elements of credit?
Standards may differ from lender to lender, but there are four core components — the four C’s — that lenders will evaluate in determining whether they will make a loan: capacity, capital, collateral and credit.
What is 4 Cs of credit?
Your ability to get a mortgage depends on four primary factors: your credit history, financial capacity, available capital and collateral.
What are the Cs in credit?
Students classify those characteristics based on the three C’s of credit (capacity, character, and collateral), assess the riskiness of lending to that …
What is capital in the 4 Cs?
Capital is another word for your net worth, or what you own minus what you owe. Lenders expect you to have enough money or other assets in your business to manage possible losses. This means it is essential to watch your money closely, keep your debts and assets balanced, and work to increase your worth over time.
What are the 4 types of credit?
There are four main types of consumer credit: installment credit, non-installment credit, revolving credit, and open credit. Installment credit is a type of credit that allows consumers to finance a purchase for a specific purpose over time.