The 3 “C’s” to understanding Home Loans

Individuals don’t purchase a home every day. Although people move more frequently now than they did in the past, obtaining a mortgage is still a complicated process and one that many don’t fully understand. For first-time home buyers, the process may seem so overwhelming they are ready to give up. This doesn’t need to be the case. Lenders typically look at three things when determining if a borrower is creditworthy and should be provided the funds they desire. These three things are credit, capacity, and collateral. Following is a more detailed explanation of these three items.

Credit
Mortgage lenders review a person’s credit score and payment history when determining if they are a good candidate for a mortgage loan, as the mortgage is leveraged against future income. Most individuals cannot pay for their new residence outright, thus a loan is essential. Thankfully, a mortgage is considered a good type of debt, as it is linked to a physical asset. The loan may be secured by the asset, unlike credit cards and many other obligations. However, individuals need to ensure they have the best credit possible before applying for this loan, as their credit score affects how much they pay in interest.

Borrowers will need to show proof of income to the lender along with other financial documents. This may include proof of their employment, a listing of assets and expenses, and more. Each lender has their own requirements in this area, thus borrowers need to ensure they have the required paperwork available. What lenders are looking for as they conduct the review of the borrower’s finances is a steady stream of income, a stable job, and low expenses in relation to the individual’s income. In addition, they don’t want to see adverse credit events such as a bankruptcy or delinquent accounts.

A person’s credit score plays a role in the interest they will pay. Individuals with a credit score of 760 or higher tend to get the best loans, yet those with a credit score of 660 or higher will still receive favorable terms. If the borrower’s credit score is below 660, he or she can expect to pay a minimum of two percentage points higher on their loan, while those with horrible credit may pay four points or more to obtain a mortgage. For this reason, individuals need to check their credit and ensure there are no mistakes before applying for a mortgage. If there are adverse events on the person’s credit, he or she should try to clear them also.

Capacity
Income remains one of the most important factors a lender looks at when determining the creditworthiness of a borrower. In this situation, income refers to more than just a person’s salary, as the lender looks at additional sources of money coming into the household. Salary is considered first, with retirement income only being counted when it will continue for a minimum of three years after the home is purchased.

Interest income and alimony may be taken into consideration in the event they have been paid for a minimum of 12 months prior to the application being submitted and will continue for 36 months following approval of the application. Finally, rental income must be from a separate investment property in order to count towards a person’s income when they are applying for a home loan. These are the standards, yet lenders may have different requirements, so the borrower needs to ask before proceeding.

Lenders vary in terms of the debt-to-income ratio they prefer. Some wish to see no more than 28 percent of a person’s housing going to their mortgage and utilities. Others, in contrast, allow 33 percent of the borrower’s income to go to the mortgage. In addition, when a lender considers this amount, they also look at the person’s total consumer debt. This includes any vehicle and student loans in addition to credit cards.

Be sure to speak to each lender to determine their debt-to-income ratio before applying for this reason. When determining this amount, borrowers need to make certain they include property insurance and taxes in the mortgage payment also. A higher down payment can make a home more affordable, so keep this in mind as well and save more if that will allow for the desired home to be purchased.

Collateral
A mortgage serves as a secured loan, meaning the lender may take possession of the home in the event the borrower doesn’t make the payments as required. The collateral may come in the form of a house, land, a mobile home, or another type of physical structure. The reason a mortgage loan functions as a collateral loan is the lender assumes less risk in this situation. They know they can take repossession of the property in this situation and then sell the asset to recoup their money. Most lenders don’t want to have to take this action, but will when necessary.

One thing borrowers need to understand is lenders typically don’t allow the borrower to obtain the full amount of the asset. They do so in an effort to ensure they can get all of their money back if they must take repossession. In addition, a third party will be called in to evaluate the asset to ensure it is given a fair market price. Borrowers need to acquire or save a down payment to obtain the amount needed to secure the home based on how much the lender will provide.

If you are looking to buy a home, take the time to review your credit history. Have any errors removed and try to correct negative items on the report when proceeding. Pay down any debt and save more for a down payment. Then and only then should a borrower begin looking at homes. Steps taken before the home buying process begins will help to smooth the process. We are here to answer any questions and to help borrowers take the steps they need to in order to secure a favorable loan. Contact us today to learn how we can be of help to you.

Get a personalized loan consult with one of our experts today.