top of page

Think of 4Cs Borrowing a Mortgage

Updated: Nov 3, 2023

In America, we use credit cards all the time. Most people have 5 or more credit cards in their wallets. We can finance almost anything, from clothes and shoes to schooling, cars, and houses. Most people finance their homes with mortgage loans. When people use a mortgage loan to finance their home, what are the lender requirements? A simple way to remember the basic lender requirements is to think of the 4 Cs: Character, Capacity, Collateral, and Capital.

First: Character refers to the credit history of a person. The lenders will check if a person pays their bills and credit cards on time. If it is a business entity, the lender will investigate the financial condition and operations of the business. Some businesses do not have a credit score, so the lender will use the owner’s personal credit score and may require the owner to guaranty the loan. For individual borrowers, the lender’s evaluation of the borrower is based largely on their credit history and their credit score. Higher credit scores lead to better borrowing opportunities. Generally, a 700 to 800 credit score range provides great opportunities for the borrower.

Factors that affect your credit score include:

· Late payments

· Delinquent accounts

· Available credit

· Total debt

How can you improve your credit score? Always pay your bills and credit cards on time. If you are renting a house, pay your rent on time. If you have delinquent accounts, try to pay them off. Try to reduce your overall debt as much as you can.

Second: Capacity measures the borrower’s ability to pay back the mortgage loan. The two important ways of measuring capacity are The Total Monthly Debt Obligation to Income Ratio (DTI) and The Total Monthly Housing Expenses to Imcome--- Housing Expense Ratio (HER). For DTI, the lenders will exam how much income you take in every month and determine if you have enough income to make the required monthly payments for both your existing debts and your new loan. Typical maximum limits for DTI Ratio are 28% for conventional loans, 31% for FHA Loans, and 41% for VA Loans. If borrowers have a total income $6000 before tax, the borrowers' total monthly debt obliation should less than $1680 ($6000x28%) of their total income for an conventional loan. That means for a borrower the total housing debt obligation should be less then 1/3 of their income. Housing Expense to Income ratio (HER) measures the relationship between total housing expenses and total income before taxes. The maximum mortgage payment includes principal, interests, taxes, and insurance (PITI), as well as any required monthly homeowners associations (HOA) dues or mortgage insurance premims(MIPs). Typical limits for HER are 36% for conventional loans, 43% for FHA Loans and 41% for VA Loans. For a converntional loan the total housing expense should less than 36%. For example, if the borrower has a total income before taxes is $10,000 per month, the borrower total housing expenses should less than $3600. A sustainable and constant high-income stream can be a good sign of the capacity of the borrower; however, if the total housing expenses and debt are too high, their HER may exceed the loan limits and they may not be approved for their new mortgage loan. If it is a business entity, the lender may examine your business operational profits, debts, and future income capabilities.

Third: Collateral is the property that the lender can recover if the loan goes into default. When you borrow money, most lenders require you give the lender a lien on assets to secure the loan. For residential loans, the collateral is a mortgage on the home. For a car loan, it is a lien on the car. If the loan goes into default, the lender can sell your house or car and use the proceeds from the sale to pay off the debt. The higher the value of the assets used for collateral, the greater the opportunity to borrow. Some businesses do not have much cash or other assets that can serve as collateral for a business loan. In those cases, the lender may require the business owner to pledge their personal assets as collateral for their business loan.

Fourth: Capital refers to the down payment when you buy a home. For a business, capital refers to cash reserves, assets, and equipment owned by the business. For a conventional loan, generally the lender requires a 20% down payment. FHA and VA loan have lower down payment requirements. Sometimes, you can get the down payment from a government assistant program or a relative’s gift. For example, the Canadian government has some programs to provide capital to help women start their own businesses. Women who have a good business plan may get capital assistance from a government grant or loan. These types of incentive programs help small businesses and minority owned businesses obtain capital to start their business.

Knowing your credit score---the character of your credit history and background helps you boost your borrowing ability.

Increasing your income and reducing your debt as much as possible as can enhance your borrowing capacity.

Accumulating more assets that can serve as loan collateral will also help you to secure your loan on the best possible terms.

Saving as much cash as possible for your business capital or house down payment is also important if you want to buy a home or start a business.

Character, capacity, collateral, and capital are the four important elements lenders evaluate before providing financing for our homes, cars, businesses or other loans. These same factors are evaluated by landlords in leasing homes as well. Remember these 4 Cs and try your best to improve them.

39 views0 comments

Recent Posts

See All