Know the 4 Factors Lenders Use to Evaluate Your Mortgage Applications

(StatePoint) Qualifying for a mortgage can be intimidating. By learning what lenders assess when deciding whether to make a loan, you can take actionable steps now toward homeownership.

While credit history is an essential metric, it’s not the only one at play. There are actually four core factors — the four C’s — that lenders consider: capacity, capital, collateral and credit. Here’s what to know about each one:

Capacity to Pay Back the Loan

Lenders want to make sure you have the means to comfortably take on a mortgage. To do so, they look at your income, employment history, savings, monthly debt payments and other financial obligations.

One of the ways lenders verify your income is by reviewing several years of your federal income tax returns and W-2s, along with current pay stubs. They evaluate your income based on:

• The source and type of income (e.g., salaried, commission or self-employed)

• How long you’ve been receiving the income and whether it’s been stable

• How long that income is expected to continue into the future

Countering that, lenders also review your recurring monthly debts or liabilities, such as car payments, student loans, credit card payments, personal loans, child support and alimony.

Capital

A review of your overall capital is used to determine your ability to make mortgage payments. Having cash reserves proves that you can manage your finances and that you have funds, in addition to your income, that you can access fairly quickly.

Cash reserves might include savings, money market funds and other investments that can be converted to cash, such as individual retirement accounts, certificates of deposit, stocks, bonds or 401(k) accounts. Along with cash reserves, other acceptable sources of capital might include gifts from family members, down payment or closing cost assistance programs, grants and sweat equity.

Lenders may also look at the last two months of statements for your checking and savings accounts, money market accounts, or investment accounts to evaluate how much capital you have.

Collateral

Lenders consider the value of the property you’re pledging as security against the loan. In the case of a mortgage, the collateral is the home you’re buying. If you don’t pay your mortgage, the mortgage company could take possession of your home. This is known as foreclosure. To determine the fair market value of the home you’d like to buy, your lender will order an appraisal of the property that will compare its value to similar homes in the neighborhood.

Credit

Lenders check your credit score and history to assess your record of paying bills and other debts on time. This helps lenders gauge your financial stability and thus your risk of defaulting on your loan. In addition, your credit score could dictate your interest rate and how much of a down payment will be required.

Freddie Mac tools can help you assess your readiness to buy a home and discover how much you may qualify to borrow. Visit myhome.freddiemac.com to access a Mortgage Amount Calculator and other home buyer preparedness resources.

Having a better understanding of how lenders evaluate potential loan applicants will give you an opportunity to prepare financially to take out a loan. It can also help you navigate the process with confidence.

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