There are four important factors that the lender will consider when reviewing your eligibility to qualify for a mortgage loan. Known as the “four C’s” of lending, lenders will consider your collateral, capital, capacity, and credit. Learn more about each of the four C’s and important considerations when preparing your mortgage application.
The four C’s of lending
CollateralCollateral is an asset that a lender accepts to secure a loan. With mortgage loans, your house serves as the collateral and provides the security that enables the lender to make the loan.
To determine if the home will provide the lender with adequate collateral, a lender will request a home appraisal to assess the value and general property condition. The lender will also consider the amount of the down payment, and whether the loan will have mortgage insurance.
Learn more about appraisals and mortgage insurance in our First-Time Homebuyers Checklist article.
Capital includes the assets you have available at the time of the mortgage transaction. It includes the funds in your bank, investment and retirement accounts. It may also include financial gifts from family members.
The amount of capital that you have available is important to the lender beyond demonstrating the ability to make the required minimum down payment and pay the closing costs. It is an indication of your ability to budget, save money and make your future mortgage payments. It can also be a source of reserves, or money that you can fall back on when your home may need repairs or other unexpected expenses come up.
Capacity is your ability to repay the loan. To measure your capacity, lenders first determine your monthly qualifying income. For income to qualify, it must have a documented history of receipt, be stable and likely to continue. This income is then used to calculate two ratios. The housing ratio is calculated by taking the proposed mortgage payment and dividing it by your gross monthly qualifying income. In general, lenders do not want to see the housing payment exceed one-third of the qualifying income.
Learn more about the composition of a mortgage payment in our Mortgage Basics article.
The debt-to-income (DTI) ratio factors in other recurring monthly debts, such as car loans, student loans, and credit card payments. To calculate your debt-to-income ratio, add these recurring payments to the proposed mortgage payment, and divide by your gross monthly qualifying income. Maximum DTI ratios can vary by program, but a good benchmark would be about 40% or less.
These ratios help the lender evaluate your ability to make the mortgage payments.
Your credit history will be reviewed closely by your lender. It is considered to be an important indicator of your overall financial health, and the likelihood that the new loan will be repaid.
A person’s credit history is often summarized through the calculation of a credit score. The one that is most commonly used by mortgage lenders is a FICO score. Your score can impact your eligibility for some loan programs, as well as the interest rate you may have to pay.
You’ll want to start by understanding how your credit score is calculated and what factors determine it. Your credit reports should be reviewed at least annually. You can obtain free reports from all three of the major credit bureaus at Annual Credit Report.com.
- No matter what a lender says, only you can determine if a mortgage is truly affordable based on your financial profile and spending habits. As the borrower, you need to be comfortable that the mortgage and property expenses are affordable for the duration of the loan.
- Be sure to save all financial documents pertaining to your assets and liabilities for at least one year, and those pertaining to your income, like tax returns and W-2 forms, for at least two.
Taking the next step on your first-time homebuyer journey
Middlesex Savings Bank is here with a team of friendly, knowledgeable experts who are ready to assist you through every step of the home buying process. We’re proud that our customers voted us first place for mortgages in the 2019 and 2020 Best of MetroWest Awards, the official community choice awards presented by The MetroWest Daily News.
If you’re ready to buy a home, our home loan specialists will help you select the best mortgage option for your needs. If you’re wondering if you’re ready to get started on the home buying journey, we’ll help you determine that too.
Contact our local Mortgage Center at 1-877-672-7654 to speak with a specialist. You may also have a specialist contact you directly by completing a simple form on our website.