What Are the Four Cs of Mortgage Approval?

If you are in the market to purchase a home, you likely need a mortgage. Understanding what it takes to qualify for a mortgage increases the likelihood of securing one.

Your ability to get a mortgage depends on four factors:

• Your credit history

• Financial capacity

• Available capital

• Collateral

Evaluating each factor helps determine whether you are ready to shop for a mortgage and purchase a home.

1. Credit

Credit is the likelihood that you will pay back the home loan. Your borrowing behavior indicates to lenders how reliable you are at paying back debt.

Mortgage lenders examine your Fair Issac Corporation (FICO) score to determine your trustworthiness as a borrower:

• FICO scores generally range from 300 to 850.

• Most home loan programs require a score of at least 620.

• A score of 740 or higher can help you qualify for the best interest rates.

You can improve your FICO score by working on the factors that influence it:

• Paying bills on time.

• Paying down debt.

• Establishing a longer credit history. 

• Keeping new accounts to a minimum. 

• Showing diverse credit types. 

Credit Report

Your credit report is a detailed account of the factors that comprise your credit score. Positive accounts are listed as long as they remain open, whereas negative information stays on your credit report for 7 to 10 years.

Regularly check your credit report to ensure everything is correct, including the following:

• Identifying information

• Employers

• Credit inquiries

• Payment history

• Judgments

• Bankruptcies

2. Capacity

Capacity is the ability to pay a mortgage:

• Lenders calculate your debt-to-income (DTI) ratio, which includes your monthly debt payments plus the mortgage payment, divided by your gross monthly income, to determine your capacity.

• Your DTI ratio impacts your home loan amount and ability to repay it.

• Generally, your DTI ratio should be 45% or less, meaning you should spend less than half your monthly income on loan payments.

• You can improve your DTI ratio by paying off debts before applying for a mortgage.

3. Capital

Capital is your resources to pay your mortgage:

• Whereas a steady income is essential, lenders want to see other liquid assets to cover your mortgage if needed.

• Your capital includes readily available funds, properties, retirement accounts, additional investments, and other assets you could sell for cash.

• More savings increase the odds of securing a mortgage.

Your minimum capital should include the following:

• A down payment: Most down payments are between 3% and 20% of the home’s purchase price, although some loan programs do not require any money down. A larger down payment can lead to a lower interest rate.

• Reserve funds: You should have available funds for annual home maintenance costs, estimated at 1% of the home’s purchase price, and at least 2 months of living expenses saved for emergencies that might arise while making your mortgage payments.

4. Collateral

Collateral is the asset you offer in case you default on your mortgage. Lenders want to know your home is worth enough to cover the cost of your loan.

Before closing on a home, have the property appraised to ensure its value justifies the amount you are borrowing:

• Your loan-to-value ratio, the amount of your loan divided by the home’s value, determines the level of risk your lender is taking on.

• A larger down payment reduces the amount of risk the lender takes on.

*This information is for educational purposes only.

Let me know in the comments which personal finance topic I should write about next!