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Mortgage lenders are in business to make home loans. If they
turn down everyone who applies for a loan they won't make
any money. On the other hand, if they approve everyone without
making sure that borrowers are able and likely to repay the
loans, lenders will not stay in business very long.
It is important to remember that the person who makes the
decision to approve or reject your loan application has only
the information in your file on which to base an opinion.
That's why it is so important that you understand exactly
what the lender is looking for and what counts most in your
favor. Having this information will enable you to be prepared
for the purchase process, and to 'work the system' to your
advantage.
To decide if you are a good credit risk, a lender looks at
four things, called the 4 Cs of credit- capital, capacity,
credit history, and collateral.
Capital
The amount of cash you have available is your capital. The
more cash you have in savings accounts, certificates of deposit,
bonds, or other places where you can get to the money quickly
if you need it, the more comfortable a lender is that you
can cope with the financial emergencies that may arise after
you move in to your new home. If you have saved capital, it
also shows the lender that you know how to budget and manage
your money, things that become even more important when you
take on the new responsibility of being a home owner.
Lenders will ask you to prove how much capital you have and
where it came from. This is called verification of deposit.
You will need to show that you have at least enough capital
to pay for the down payment, loan fees, closing costs and
escrow impounds and reserves.
Even though lenders prefer that you have saved the capital
yourself, they realize that this is difficult for low-income
borrowers. Some loan pro- grams allow you to use some of your
own savings and some money you received as a gift or a grant,
in order to get the capital you need to qualify for a loan.
Capacity
Your ability to earn enough income to make the new mortgage
loan payments and still pay all of your other living expenses
is called your capacity. Lenders need to see that you have
the capacity or ability to repay the loan. When lenders look
at capacity, they look at three things.
First, they look at your current income. The lender needs
to see that you (and your spouse if you are married) currently
earn enough to pay the new house payment and other expenses
like taxes and insurance, and still live comfortably. You
may think of your income as your take-home pay-income you
have after taxes have been taken out. However, when you are
qualifying for a mortgage, the lender will use your gross
income. Gross income is the money you earn before taxes. Gross
income also includes overtime pay, commissions, dividends,
and any other money that is part of your regular income. Remember,
as long as you can show a steady history of income, the lender
can count it.
Next, a lender looks at your income history, your employment
history and future earning potential. Lenders want to know
the following:
• Can you show that you have held steady jobs and earned
a stable income for the past two years?
• How long have your held your current job?
• Is it likely that you will continue to be employed
at this rate of pay or better for the next two years?
It is fine if you have not been employed at the same place
for two years, as long as you have been employed somewhere
and have had steady Income.
Lenders will ask for proof of your jobs and income, called
verification of employment. You can show pay stubs, tax returns,
or other kinds of proof. The lender will also contact your
past and present employers to verify how much you earn and
that you are likely to continue to work there in the future.
Another important factor is the amount you owe. The lender
will use all creditor debts such as monthly payments on loans,
charge cards, child support, etc. Listed below are the typical
types of debts taken into consideration by mort-gage lenders.
Installment accounts. Auto payments, furniture payments, and
student loan payments are called installment because they
have the same payment each month. Often the lender will discount
these payments, or not use them, if the number of payments
remaining is fewer than six months.
Revolving charge accounts. Visa, MasterCard, and department
store accounts are examples of revolving credit. The minimum
payment on these accounts can go up, or down, depending on
the outstanding balance. The lender will use the mini- mum
monthly payment on your most recent statement to calculate
your debt.
Other monthly payments. Child support payments, child care
expenses, alimony, and wage garnishments are also used by
the lender to calculate the amount of your total monthly debt
payments.
Exceptions to the rule: Lenders do not include certain types
of monthly bills. For example: telephone and utility bills,
auto and life insurance bills, retirement and savings contributions,
income and Social Security taxes, and union dues are not used
by lenders to determine your total monthly debt payment.
Credit History
One of the best ways for a lender to tell if you will repay
your home loan is to look at how you have handled your other
debts. If you have always repaid the money you have borrowed
on time, if you generally pay cash for things, saving credit
cards for large purchases and emergencies, you are probably
a good credit risk. On the other hand, if you have many loans
and credit cards and struggle to make the minimum payments
that are due each month, you may need to improve your credit
history before a lender would be willing to make you a home
loan.
In order to check your credit history, the lender will get
a copy of your credit report from one of the major credit
rating agencies. The credit report will list every company
you have borrowed money from in the past seven years; how
much you borrowed; whether you paid the money back; and how
many times your payment for each debt was 30, 60, or more
days late. It will also show more serious problems like open
collection accounts, judgments, foreclosures, or bankruptcies.
If you have had a foreclosure or bankruptcy within the past
10 years, it will be very difficult for you to convince a
lender to make you a new home loan. If you have several late
payments, an open collection account, or a judgment, you will
have to explain the circumstances to the lender in a way that
convinces the lender that whatever situation caused those
problems has been solved and your credit is improving. Credit
history is so important in making the loan approval decision
that the lender will probably ask you to explain even a single
late payment.
No Credit History
Many people do not have a credit history. They do not have
a checking account or credit cards and have not borrowed money
from banks. Because of this it is hard for a lender to tell
if they will be able to handle the responsibility of a large
home loan. If you do not have a credit history, your loan
officer or nonprofit housing counselor can help you build
one by gathering check stubs, bill stubs, receipts, or payment
slips showing your regular monthly payments to landlords,
utility and phone companies, child care providers, and others.
This is called a nontraditional credit history. The idea is
to show a lender that you pay your bills on time.
Collateral
Your new home will be collateral or extra security for your
loan. Your lender will look carefully at the value and condition
of the house to make sure it is worth at least as much money
as you are borrowing and to be sure that the house does not
have any major repair problems that could cost you more money
than you planned.
Lenders generally determine value by hiring an appraiser.
You will be asked to pay for the cost of the appraisal when
you turn in your loan application. The appraiser uses his
professional training to estimate the fair market value of
the house. Because lenders want you to invest some of your
own money in the house, they will generally lend less than
the fair market value. The appraisal is used to calculate
a loan-to-value ratio, which helps the lender determine how
much to lend and tells you how much of a down payment you
will need.
Lenders review the appraisal not just for value but also to
make sure the house is in decent condition. If the appraisal
shows that any of the major parts of the house are not in
good shape (or for instance, the house needs a new roof),
the lender may agree to make the loan only if the roof is
replaced first. This is called a property condition contingency.
It is for your protection as well as the lenders.
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