Buying a home isn't easy. Most attend dozens of open houses before finally finding The One. Then the work begins.
You have to convince a mortgage banker that you're up for the job. You meet with the lender, singing "Take on meeeee" in your head, but the classic 80s band A-Ha won't help you get a mortgage if you haven't cleaned up your act beforehand.
When they review your application, lenders try to determine your ability to pay off your loan. After all, they're taking a chance on you and they need to minimize risk as much as they can. Let's talk about the primary factors a lender looks for when you apply for a mortgage. The better you do on the Five Cs, the more likely you'll be signing on the dotted line.
First on the list is your credit report and credit score. Lenders focus in on three specific components of your credit report.
- Payment History: If you've missed several payments and allowed accounts to become delinquent, the lender isn't likely to believe that you can handle large mortgage payments every month.
- Debt-to-Income Ratio: The lower your outstanding debt is in relation to your total gross income, the more confident a lender will be that you have room to comfortably fit in a mortgage payment.
- Age of Credit History: Don't jeopardize your age of credit by opening a new account around the same time or shortly before you apply for a mortgage. A creditor might wonder why you suddenly need more credit.
Capacity looks at your financial ability to pay a mortgage. It isn't enough to land a cushy job three months before you apply for a mortgage. Lenders often verify at least two years of employment. They like to see how long you've stayed at one company and that you have a stable source of income. Leaving a company looks concerning (unless you left for a larger paycheck in the same profession) and, unfortunately, career changes make you more of a gamble. A lender doesn't know if your brand new bakery will be as successful as your six-year architect stint was.
If you work an unconventional job or own your own business, prepare to provide your tax returns and answer more questions. The type of income you generate also makes a difference. If you're guaranteed a paycheck every month, great! Commissions and bonuses, however, come and go and make you appear less reliable.
Having a substantial amount of money in the bank makes you more appealing to a banker. They want to see that your assets are stored in liquid checking and savings accounts, so you can easily withdraw money to pay your mortgage bills if you need to. Investment and retirement accounts also count as assets, even if you can't access them as easily. It's wise to accumulate these savings over an extended period of time. This will show that you've been racking up reinforcements and you didn't deposit a one-time generous gift from your grandparents to make you look good.
The last two C's are out of your control. Conditions refer to the state of the housing market and economy and what you're planning on using this loan for. Lenders may also want to know what your reason is for buying this home. Renting out a home will generate you significantly more income than if you plan on living in it full-time. Lenders basically want to see what outside influences may impact the value of your property and your ability to pay off your loan.
Collateral represents the assets lenders can take from you if you can't pay off your mortgage. How much is this property worth to the bank if the loan goes south? The appraisal will tell them the value of the home you're eyeing and if the home will be worth anything if they seize it. The conditions of your loan help identify outside risks, and collateral helps lenders reduce that risk.
Basically, when lenders receive your mortgage application, they have to decide if they're willing to stick their neck out for you. It's a tough process, but lenders are going to try to account for all the pieces of your risk potential pie. It's all about fiscal responsibility in the end. If you score well on the Five C's, you'll be on your way to painting that picket fence with a fresh white coat. Here's to landing your dream home.
About the Author: Charmaine Ng is the Communications Coordinator at Credit Karma. When she isn't writing her way through life, you can find her reading about the latest in entertainment and watching television almost every night of the week. Say "hi" @noodlemaine!
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