The 4 C’s are the four factors underwriters look at to determine whether or not you qualify for a mortgage.
Understand How A Mortgage Application Gets Reviewed and Qualified
So you’ve finally decided to take the plunge and buy a new house. Ever wondered what goes on behind the scenes and what the questions, qualifications and factors are that make the difference between an approval and denial?
Given that our mission is to supply the community with tools and education and to enable everyone to be an informed, educated, and empowered consumer, here we will give an overview of how an underwriter analyzes an application (AKA the person who decides on the outcome of your application)to see if you qualify for a mortgage.
“The 4 C’s of Underwriting”-Credit, Capacity, Collateral and Capital.Guidelines and risk tolerances change, but the core criteria do not.
Credit
Credit… the dreaded word! The truth is, the number behind your credit score doesn’t need to be such a mystery.
Credit refers to the prediction of a borrower’s repayment based on the analysis of their past credit repayment. To determine an applicant’s credit score, lenders will use the middle of the three credit scores reported by the three credit bureaus (Transunion, Equifax, & Experian). The results are your credit report.
By reviewing one’s financial factors, such as payment history, total debt compared to total available debt, the types of debt (revolving credit vs. installment debt outstanding), a credit score is given each borrower which reflects the probability of well managed and repaid debt. A higher score tells a lender that there is a lower risk, which results in a better rate and term for the borrower. The lender will look to run credit early on, to see what challenges may (or may not) present themselves.
Capacity
In addition to reviewing an applicant’s credit, lenders want to analyze their ability to repay the mortgage over time. Capacityis the analysis of comparing a borrower’s income to their debt. The primary tool they use for this analysis is a debt-to-income ratio. Simply put, the debt-to-income ratio is the sum of all monthly payment obligations an applicant has (including the potential upcoming housing payment) divided by their gross monthly income.
However, keep in mind every application is different. Consult a Mortgage Advisor to determine how the underwriter will calculate your numbers.
Collateral
Collateral refers to the security of your loan in case of any issue that may arise that prevents repayments.
This is usually done through the appraisal of your home. An appraisal considers many factors – sales of comparable homes, location of the home, size of the home, condition of the home, cost to rebuild the home, and even rental income options. Obviously, the lender does not want to foreclose (they aren’t in the real estate business!) but they do need to have something to secure the loan, in case the payments stops (also known as default).
Capital/Cash
Capital is a review of your finances after you close. There are two separate parts here – cash in the deal and cash in reserves.
Cash in reserves: Important considerations for a lender are: Does an applicant have a financial cushion to fall back on if their income is unexpectedly interrupted for a period of time? Has the applicant shown a pattern and habit of saving money over time? Do they have capital accounts with liquid assets that a borrower could access if need be?
Cash in the deal: Simply put, the more of your own money involved, the stronger the loan application. At the same time, the more money you have after closing, the less likely you are to default. Two prospective borrowers that each have the same income and credit scores have different risk levels if one has $100,000 after closing and the other has $100. Makes sense, doesn’t it?
Each of the 4 C’s are important, but it’s really the combination of them that is key.Strong income ratios and a large down payment can balance out some credit issues. Similarly, strong credit histories help higher ratios and good credit and income can overcome lesser down payments. Talk openly and freely with your Mortgage Advisor.They are on your side, advocating for you and looking to structure your loan as favorably as possible!
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FAQs
Standards may differ from lender to lender, but there are four core components — the four C's — that lenders will evaluate in determining whether they will make a loan: capacity, capital, collateral and credit.
What are the 4 Cs in loan? ›
Concept 86: Four Cs (Capacity, Collateral, Covenants, and Character) of Traditional Credit Analysis.
What are the 4 Cs that lenders are looking at? ›
Lenders consider four criteria, also known as the 4 C's: Capacity, Capital, Credit, and Collateral.
Which of the 4 Cs refers to your ability to earn enough verifiable income to make the mortgage payment and cover all other living expenses? ›
Capacity. Your capacity is your ability to repay the mortgage loan. Lenders look at your income, employment, and debt to determine how much you can afford to borrow and whether you can make the monthly payments.
What are the 4 elements of a mortgage? ›
Your monthly mortgage payment typically has four parts: loan principal, loan interest, taxes, and insurance. If you've never owned a home before, you may be surprised that a mortgage payment has that many components. By including these costs in one monthly payment, your lender helps make things easier for you.
How do banks determine if you qualify for a loan? ›
Your income and employment history are good indicators of your ability to repay outstanding debt. Income amount, stability, and type of income may all be considered. The ratio of your current and any new debt as compared to your before-tax income, known as debt-to-income ratio (DTI), may be evaluated.
What does the 4 Cs stand for? ›
The 21st century learning skills are often called the 4 C's: critical thinking, creative thinking, communicating, and collaborating. These skills help students learn, and so they are vital to success in school and beyond.
What does Cs stand for in mortgage? ›
Final Thoughts. Credit, Capacity, Cash, and Collateral are the four Cs of home loans. Knowing them inside and out and making each a priority before purchasing a home will ensure you get the best rates and repayment options out there.
What are the 4 Cs of income? ›
- Creation of Income. The primary focus. ...
- Consumption of Income. This involves expending the income on necessities and other arenas. ...
- Continuation of Income. The most important, yet the most overlooked aspect of family welfare. ...
- Conservation of Income. This might be listed last but never should be the last step.
Character, capital, capacity, and collateral – purpose isn't tied entirely to any one of the four Cs of credit worthiness. If your business is lacking in one of the Cs, it doesn't mean it has a weak purpose, and vice versa.
Here is what lenders look at when it comes to each of these factors so you can understand how they make their decisions.
- Capacity. Capacity refers to the borrower's ability to pay back a loan. ...
- Capital. ...
- Collateral. ...
- Character. ...
- The Other “C” of Credit.
The 5 C's of credit are character, capacity, capital, collateral and conditions. When you apply for a loan, mortgage or credit card, the lender will want to know you can pay back the money as agreed. Lenders will look at your creditworthiness, or how you've managed debt and whether you can take on more.
What are the 4 Cs of underwriting? ›
Meet the Fantastic Four - the 4 C's: Capacity, Credit, Collateral, and Capital. These titans hold the power to make or break your dream of homeownership. They're the guardians of mortgage approval, keeping a watchful eye on every aspect of your financial life.
Which of the 4 Cs of creditworthiness indicates your ability to repay a loan? ›
Of the Four C's of Credit, capacity is often the most important. Capacity refers to a borrower's ability to pay back his/her loan. Obviously, your ability to pay back a loan is an important factor for a lender when considering you for a loan, but different lenders will measure this ability in different ways.
What are the four Cs of credit earning potential and available cash? ›
The four 'Cs' of credit are : Character, Capacity or Cashflow, Capital and Conditions. Out of the 4 'Cs' of credit, the two 'Cs' that deal with the earning potential and available cash are 'Capacity' and 'Capital'.
What are the 4 types of qualified mortgages? ›
There are four types of QMs – General, Temporary, Small Creditor, and Balloon-Payment. Of the four types of QMs, two types – General and Temporary QMs – can be originated by all creditors. The other two types – Small Creditor and Balloon-Payment QMs – can only be originated by small creditors.
What are the 3 Cs in mortgage? ›
After the above documents (and possibly a few others) are gathered, an underwriter gets down to business. They evaluate credit and payment history, income and assets available for a down payment and categorize their findings as the Three C's: Capacity, Credit and Collateral.
What are the 4cs of credit analysis? ›
The “4 Cs” of credit—capacity, collateral, covenants, and character—provide a useful framework for evaluating credit risk. Credit analysis focuses on an issuer's ability to generate cash flow.
