When you join into a mortgage relationship with a lender, it’s important to keep in mind that it is the lender who generally takes on the majority of the risk as most people put less than 50% up to only 5% of their own money to finance the initial cost of the home. In order to evaluate if the applicant they lend to is going to be able to keep up their end of the bargain- ie. make their mortgage payments on time- mortgage lenders will look at 5 key indicators to evaluate the amount of risk that an applicant represents.
These 5 key indicators are most commonly known as The 5 c’s of credit which include: character, credit, capacity, capital and collateral.
Character and Credit- stability and credit
The first two- Character and Credit are related in that these they both consider the question as to whether or not the applicant has a willingness to repay debt, the attitude they have toward money and credit, and their overall stability of character. People who tend to be “good payers” of debt, tend to have a high degree of stability in their life, and show they have managed money and credit in the past.
The evaluation methods regarding character of the person may look at age, education, occupation, work experience and current residence.
The credit of an individual will largely weigh on looking at the applicants credit status. The repayment behaviour that appears on the credit report will show a persons attitude toward money. If you carry large debt load, don’t make payments on time or don’t use credit at all, this can impact the risk level. Often people think that if they don’t use credit they will have good credit- unfortunately not using credit shows no credit information to a lender- they want to see that you use credit responsibly and the only way to show that is by using it and using it responsibly.
Capacity- balances the money-Income and debts
Refers to an applicants “capacity” or ability to repay the debt/s. It will look at what money comes in, and what money goes out and the relationship between the two. This evaluation will consider age, the type of employment , job stability, amount of income they make, their debt load, assets, and their overall net worth.
Capacity will look at percentage of the borrowers qualifiable income to cover housing cost – Gross Debt Service (GDS) as well as any other monthly debt obligations -Total Debt Service (TDS).
Capital and Collateral- their assets both cash, collateral and the property.
Capital and collateral are also related because they both look at security and the question of what if the client can’t pay and do they have a cushion in case of an interruption in income.
Capital refers to the amount of money a person possesses (invested or accessible cash) and collateral refers to the property or assets that could be sold for cash. These assets provide some comfort or security to a lender because in the event a borrower defaults on their mortgage, they could be used to recoup losses. The property the applicant wants to purchase will likely be the main form of collateral for a mortgage and so the quality of the property is going to be a really important factor in an approval.
