Are You Really Ready to Buy Your Next Home?
But are you really ready to buy?
The very first step in your homebuying journey should include getting pre-approved for a home loan. Without a pre-approval, you’re highly unlikely to get a seller to seriously consider your offer. And that means you could miss out on the home of your dreams!
As part of this process you’ll likely hear your bank, or your mortgage broker, talk about the “Five Cs” of credit. Let’s take a peek at those and see how they impact your ability to get approved for a mortgage loan.
The “Five Cs” of Credit
The “5 Cs” are:
Let’s take a look at how and why each of these elements are so important.
In the good old days, before intricate credit scoring models were the norm (and, frankly, life was a lot simpler!), borrowers often received loans based on their character. Reputation often played a big role in whether a loan was granted.
Today, character is often measured by your credit score. This 3-digit number reflects the information in your credit reports, and is an estimate of your ability to repay a loan, based on:
- Your payment history (do you make payments on time)
- The total amount of debt you owe
- How many accounts you have (credit cards, student loans, auto loans, etc.)
- Your debt-to-income ratio
- The types of credit you use (loans, credit cards, lines of credit, retail accounts)
- How long you’ve used credit (and if you’ve used it responsibly)
The average credit score is 725, and the higher the score, the better. Borrowers with higher credit scores will be able to receive better interest rates than their lower-score counterparts. Most conventional loans require a minimum 640 credit score; FHA and VA loans require at scores of at least 580. While you may be able to get a loan with low credit scores, you will pay a higher rate for your loan.
It’s a good idea to regularly check your credit reports. Credit Karma offers free credit reports from two of the major consumer bureaus.
Capacity is based on your financial ability to repay the loan and is usually measured by income and employment.
Lenders may factor stability into the mortgage equation; as a result, borrowers with significant time in their jobs – or fewer jobs in their work history – may be perceived to be more stable.
Your debt-to-income ratio (or DTI) will play a significant role in determining capacity. The lower this ratio, the better. Average ratios are in the 36% – 38% range.
To calculate your DTI, add up all your monthly debts. This includes payments for credit cards, loans, and other obligations (such as alimony and insurance). Then divide that amount by your monthly pre-tax income. The result will be your DTI.
If your debt-to-income ratio is off-balance because you have too much debt compared to your income, it may mean you will qualify for a smaller loan amount.
The money that’s left after you buy a home, along with any investments, other properties, and assets you can liquidate quickly is your capital.
Many buyers wonder why capital is important. Although your home is likely the largest single purchase you’ll make, lenders don’t want to see you left with no reserves after you buy a home. The cash cushion that capital creates is your personal “shock absorber” – and could be essential if your home needs unexpected repairs, if you suffer a job loss, or you are unable to work for a period of time due to illness.
When you’re planning your home purchase, remember the down payment is only a portion of the funds you’ll need to have on hand. Be sure to plan for additional capital. When interviewing banks and potential mortgage lenders, be sure to ask how much money they want you to have available to meet their guidelines.
Simply put, collateral secures a loan. When that loan is for a home, the collateral is almost always the home itself. The lender is depending on the value of the collateral in the event a borrow defaults on a home.
This is one reason lenders typically require a home appraisal (and often, a home inspection) prior to granting a mortgage. They want to know that the value of the home will support the mortgage in case the buyer can’t make their payments and they’re forced to take the home back.
While the other four C’s relate to your personal situation, the fifth C – condition – is focused on external factors.
These can run the gamut from mortgage rates, the local real estate market, the cost of living, and the general economy.
Lenders may be more willing to lend money at more favorable rates when the market is ticking up … and lending restrictions can tighten in a “down” market. Your agent can help you understand whether you’re looking in a buyer’s, seller’s, or neutral market.
Cleaning Up Your Credit
If you find problems on your credit report, it’s a good idea to get started today on fixing them, even if you’re not planning on purchasing right away.
Even a single issue on your report could take as long as 30 days to correct. Don’t wait until you’ve found a home you love to start the credit repair process. At that point in time it might be too late!
Buying with Confidence
Knowing the five Cs of credit can give your confidence a huge boost (and could mean money in your pocket!).
Use the five Cs to help you prepare, help you negotiate, and help you end up in the South King County home of your dreams!
Need a referral to a great mortgage lender? Let us help! We have long-term relationships with excellent lenders, and would be happy to connect you. Just contact us at 253-246-8938 or firstname.lastname@example.org to get started.
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