Various lenders in the market offer multiple plans and mortgage products that you can work with to secure financing for your home. But you should always keep your options open and sniff around to know your options and know what’s best for you before finalizing the mortgage. Check out “blogs to question to ask the lender.”
Before any lender offers or finalizes the mortgage for your home purchase, they will typically lookout for “Five Cs of Credit“. And these Five Cs of Credit are character, capacity, capital, conditions, collateral to measure the creditworthiness of you or any other co-applicant involved in the loan. These five c’s holds great importance for every applicant in determining the risk factor from the lender’s perspective, directly impacting mortgage credibility and approval.
Character – Credit History
First and foremost, lenders would be interested in reviewing your credit history before proceeding with a mortgage application request. Credit History helps the lender gauge the borrower’s ability to repay loans and fulfill debt-related obligations. For any individual, their credit history is attainable from their credit report. The credit report provides a detailed summary and breakdown of the borrower’s credit history, which is usually prepared by credit reporting agencies or organizations like Trans Union and Equifax in Canada. These agencies are also known as credit bureaus. Credit Bureaus will start a credit report or, say, a credit file on an individual for the first time when they open a credit product or borrow money. Any credit account or product that was ever opened, closed, or still open is recorded in a credit report. Credit Report will also have information about available credit or credit used by an individual, any bankruptcies, bill payments if delayed, recent credit inquiries, and much more.
All this information available in the credit report is used by the potential creditors or mortgage lenders to decide whether they can provide loans or not. And the best way to be in good books for the lender is to have a good credit history. Maintaining a good credit history means paying off your credit bills on time and, in total, paying all utility bills on time, making existing mortgage payments on time, and much more. Conversely, bad credit history will build up over time if individuals don’t pay off their debts and loans. Their account might show previous bankruptcies, foreclosures, refusal, and many more issues. Therefore, keep mindful of your debts and loans and their timely payments. Hence, having a good credit history is a critical requirement that needs to be satisfied to sucre a loan or mortgage from a lender.
Capacity – Debt-To-Income Ratio
Measuring the borrower’s capacity when it comes to providing the mortgage means the lender is measuring the borrower’s ability to pay back the loan amount eventually based on the borrower’s income and comparing it with their debt-to-income ratio (DTI) and recurring debt obligations. DTI ratio shows what percent of your gross income goes towards paying off your debts. The value of the DTI ratio helps lenders evaluate the borrower’s ability to manage monthly payments and repay loans. Whenever you go to any lender for a small or big loan, they will verify and calculate your debt-to-income ratio before qualifying you. Usually, the lender favour borrower with a small debt-to-income ratio. DTI ratio value calculation is independent of the credit history and credit score and is solely based on income and repayment of debts. In contrast, credit history does not factor in the income earned. DTI has two sub calculations, i.e., Gross Debt Service Ratio (GDS) and Total Debt Service Ratio(TDS).
Gross Debt Service Ratio (GDS) represents what percent of the borrower’s gross income will cover principle, interests, and property tax payments (PIT). GDS can also include monthly rental and utility bills adding up to monthly expenses. An acceptable range of GDS Ratio is between 27 to 32 percent but based on the market situation; your lender might prefer lower values.
Total Debt Service Ratio (TDS) includes all debt obligations plus everything used in GDS calculations. Hence includes personal loans, credit debts, student loans, mortgage payments, principal amount, interest owed, and land taxes. The most acceptable TDS ratio varies between 37 to 40 percent, but the lender can prefer even lower values.
For mortgage purposes, the lower the debt-to-income ratio is better is the chance is to get better insurance. Simple solutions to reduce the DTI ratio are that individuals can make a conscious effort to lower their recurring debts, increase their gross income, or combine both. An individual who is serious about making their first home purchase should practice reducing the expenditure on the things that fall in the category of ‘what they want’ and restricting the budget to ‘what they need’ and save the rest.
Capital – Liquid money
As a basic rule of financial credibility, the more personal capital the borrower puts towards the potential purchase, the more likely they will secure a better mortgage. The more significant the contribution in the form of down payment, the more invested the borrower would be, reducing the chances of mortgage defaults. While buyers contribute a higher amount towards their purchase’s down payment, the remainder of the money they need to borrow from the lender will be a lower mortgaged amount. Therefore, loan interest rates and payments will be lower as the lender will look upon this borrower as a low-risk client. And the inverse of this is true as well. But depending on the borrower’s finances, the lender might require them to pay 0 to 50 percent of purchase prices as the down payment.
If the borrower is a low-risk client, the lender might offer them the conventional mortgage where the borrower will pay at least 20 percent of the property’s sale value as the down payment. Whereas, if the borrower is more likely to default according to the lender’s books, the lender might refuse their mortgage application or offer them a high ratio mortgage. With a higher ratio mortgage, the borrower will be putting lower than 20 percent of the property’s sale value towards the down payment but will more likely be required to get a mortgage default insurance for the lender’s safety.
Collateral – Asset to back the loan
Collateral means any asset or a resource of economic value that the borrower owns or possesses that they can provide to the lender in the form of security to secure a loan or mortgage. The collateral protects the lender involving the amount of finance they have invested in the borrower’s purchase or property in the form of a mortgage or loan. If the borrower defaults on the periodic repayment towards this mortgage amount, and then, in that case, the lender has legal right to seize and sell the borrower’s property in foreclosure to recover their investment. In mortgage market terminology, the loans backed up by some valuable collaterals are termed secured debts. They are deemed less risky for the lender.
Condition – Intention, Amount, and Interest Rate
Before the lender grants you a loan or mortgage, the lender will register certain conditions to the loan itself, which refers to the terms and conditions of the loan. These conditions state what happens with the loan and its assignment in the event of some change in economic conditions, industry trends, government policies, or something very personal to the borrower. These also highlight specific criteria of loan provisioning. The lender further evaluates the requirements and purposes of the mortgage and appraised value and might factor in interest rates, principal, terms to assess the conditions. This all is done in conjunction with an overall evaluation of the risk and liability of offering the loan.
When you are just starting and looking to buy your first ever home, sometimes all these factors mentioned above might seem overwhelming and a bit too much to engulf. BUT, you do not have to do this alone. We all are human and need each other’s support to move further. Do not hesitate to reach out and ask any question, no matter how tiniest it is, as we all started somewhere.
