6 C’s of Credit
When you apply for a mortgage you have to undergo a process of evaluation before you will be given an approval. The process called credit evaluation can take time and always involves an end, either an approval for the mortgage or a decline. If you are declined, you may be given alternative options such as private loans or a plan to help you to qualify in the future.
The lender’s credit evaluation involves 6 main areas:
1. Capacity: your cash flow to service the mortgage payments
When Lenders talk about ‘capacity,’ they are referring to your ability to manage the mortgage payment based on your proven household income as well as how much other debt you have. They consider your income, the nature of that income, length of time on the job or in business and whether or not you are able to prove that income. Non‐income Qualification (NIQ) mortgages are available where income does not have to be proven with traditional documentation but these types of loans are tough to qualify for. The lender will typically set higher standards in all other areas of qualification such as your credit rating and marketability of the property etc.
Types of Income: Establishing what your usable ‘qualifying income’ is for the purpose of financing can be challenging. It is crucial that you disclose the details of how you derive your income or incomes. The lenders have different documentation requirements for each of the following types:
- Self Employed ‐ Sole Proprietor, Partnership or Corporation
- Salary plus commission
- Part‐time employment
- Permanent or casual employment
- Tips / bonus income
- Contractual income
- Pension income
- Disability income (temporary or permanent)
- Taxable or non‐taxable income
- Spousal support
- Rental income
2. Credit: your ‘creditworthiness’ according to credit bureau reports
When you use credit, such as credit cards, car loans, lines of credit etc your repayment history is reported to the credit bureau. All Lenders refer to the credit report when considering your ‘creditworthiness’ before lending to you.
If you are late on making a payment it is reported for all future lenders to see. Length of time on the credit bureau, repayment history, and utilization (how close you are to the limits on your credit cards) are all taken into account.
Your credit file is rated with a ‘fluctuating’ numeric score between 300 and 900, known as a beacon score. It is predictive of your credit worthiness at a particular point in time. The higher your score the more likely you are to be approved for a mortgage and the more likely you will be offered lower rates.
3. Capital: Assets – Debts = Net Worth
Capital refers to your personal net worth and how much equity you have in the property.
Net Worth: Your net worth is the value of your assets less any debts that you have. Lenders look at your net worth to determine your spending habits. Those applicants with a low or negative net worth may be turned down for mortgage financing even though their debt service ratios are in line.
Equity In The Property: Equity is the difference between the current market value of your home and all outstanding mortgages against the property. The larger your down payment the less the risk for the lender.
4. Collateral: the real estate asset used to secure the debt
Collateral reflects the strength of the property itself. An owner occupied, single family residence on a standard city lot in a major metropolitan area is considered low risk to a lender. As a property moves further from that description the risk is increased. A condominium, a rental property, a property in a more rural location or acreage would all be examples of properties that would be higher risk for a lender, primarily due to marketability.
5. Conditions: of the borrower and the overall economy
Conditions describe the intended purpose of the mortgage loan. Is the mortgage being used to purchase an owner occupied home, a rental property or as an investment that will be flipped for a potential profit, etc. All of these conditions influence the risk for the lender.
The lender will also consider local, national and global economic conditions and the overall climate, in the real estate market that could affect the value and marketability of the property.
6. Character: integrity and overall risk
Lenders do not know you personally and therefore rely on the information you have provided on your mortgage application and your documentation. Character is the most subjective rating but reflects a combination of many factors:
- Declared income versus borrower’s accumulated savings
- Declared income versus employment type
- Length of employment versus borrower’s age
- Has the person declared bankruptcy in the past?
- Does the person have a good credit record?
- Does he/she have a stable job?
- What is the level of education/experience?
- What is the person earning and what is the earning potential?