Buying your first home can be an exciting journey. For most of us, mortgage underwriting is an unavoidable part of that process. Underwriting is when a lender reviews your final mortgage application to decide whether to give you a loan and if so, under what conditions (ex: a higher or lower interest rate). Even if you were pre-approved for a mortgage, you will still have to go through this final underwriting process. When reviewing an application, lenders consider four criteria (the “C’s”) to decide whether to approve or deny a loan. Like a checklist, all four areas must be satisfied for your application to be approved. Keep reading to learn more about the four C’s of home buying:
Credit – Let’s start with the elephant in the room. Lenders check your credit score and credit history to get an idea of how you’ve handled current and past loans. When evaluating your credit, underwriters use your Experian, Equifax, and TransUnion FICO scores as a quick way to predict your likelihood of repaying the loan. A FICO mortgage score of 640 is generally considered “mortgage ready,” but specific requirements may be higher or lower depending on loan programs and lenders. If you’re not sure where you stand, you can request free copies of your credit reports through annualcreditreport.com. Be sure to watch our Credit 101 and How to Read a Credit Report class recordings on YouTube to learn more credit basics.
Capacity – Capacity refers to your ability to comfortably afford mortgage payments, plus other existing financial obligations. Lenders will look at your gross monthly income, two years of employment history, and current monthly debt obligations to determine capacity. When it’s time to crunch numbers, they’ll use your income and monthly debt obligations to determine if your debt-to-income ratio (DTI) fits within their lending requirements. DTI limits vary depending on which kind of mortgage you’re applying for (ex: conventional vs. FHA vs. VA), as well as any additional requirements a financial institution may have.
Capital – When you hear capital, think cash. Capital is important because it shows the lender that you won’t be completely broke after covering your down payment, closing costs, and other expenses associated with buying a home. A common requirement is having at least two months of mortgage payments saved in a rainy day fund (also known as “reserves”) separate from whatever money you’re using to purchase a home. You can use bank accounts, monetary gifts (under certain conditions), and assets like investments or retirement to prove sufficient reserves. Here’s a full list of acceptable sources for reserves.
Collateral – This refers to the house itself. Underwriters consider a home’s appraised value when deciding whether to approve a mortgage application. Property size, location, condition, and the value of nearby homes are just some of the things considered when a house is appraised. Even if you ace the first three C’s, if a home doesn’t appraise well the final loan will not be approved. This is because collateral ensures that the lender won’t lose their money if you default on the loan.
At the end of the day, securing a home loan comes down to the four C’s: credit, capacity, capital, and collateral. Whether it’s down payment assistance, free credit coaching, or a trustworthy realtor, there’s plenty of support so you don’t have to go through the process alone. To learn more about the 4C’s and how to become mortgage-ready, follow this link to register for our “4C’s of Homebuying” class on June 17, 2021. You can also meet with a free Prosperity Connection financial coach to evaluate your position and prepare for the mortgage application process.
Nay’Chelle Harris, Financial Coach