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Why Borrowers Want To Bring Home All C's Peter G. Miller - Mortgage Lenders Plus.com Add to Delicious, diggit, reddit, technorati favs

Back in the good old days, solid performance in school meant getting a string of A's and maybe a few B's. But when it comes to lending you can score best by doing well with four C's.

Why C's and not A's or B's? Lenders need a quick and fair way to grade the mortgage applications they receive. The idea is to match the right borrower with the right loan to assure that borrowers pay no more than they should for real estate financing. For borrowers, the importance of this system is to know how it works so you can get the best possible financing.

What Happens When You Apply For A Loan

The usual process for getting a loan looks like this: You submit a mortgage application to a loan officer. The loan officer wants to get as much information as possible to build a file for an underwriter. The underwriter then evaluates the file and determines whether or not the borrower qualifies for a loan, how much can be financed and which program is best.

There are some complications in this process. For instance, if the loan is underwritten with a computer program and a borrower is accepted, that's good news. If a borrower is declined by an automated program, then the file is passed on to a real human for review. Another complexity: If an underwriter looks at a loan file and sees something which is missing or unclear then the borrower will be asked for more documentation. This is done to assure that the underwriter can make the best possible decision.

But whether machine or human, four central qualities count when looking at a loan application. Get your C's right and you'll do well in the lending process.

1. Character or Credit History

The number one question every lender asks is this: If I make this loan is the borrower likely to repay? This is not just a question of money because people with big incomes can have a slew of missed payments, no payments, foreclosures and bankruptcies. Alternatively, individuals with modest incomes can have high credit ratings because they live within their means and pay bills in full and on time.

Credit reports generally include information going back seven years, however when lenders look at a credit report they're most interested in your activities during the past year or two.

What is it that lenders want to know?

• Does your credit report show negative items such as payments that were at least 30 days late?
• How many accounts do you have that are in good standing? Bad standing?
• What is the credit limit or original balance for each account.
• What is the recent balance for each account?
• What is the status of the account: Open? Closed? Paid? Never Late?

While lenders can review each account in a credit report, a quicker approach is to check an individual's credit score, a mathematical formula that lenders use to rank an individual's credit standing.

2. Capacity

Having great credit is important, but lenders also want to know that you have the ability to repay a mortgage. To determine your financial capacity lenders look at two measures or "ratios": The "front" ratio compares your monthly housing expenses -- principal, interest, taxes and insurance or PITI -- to your monthly income. Lenders will also look at all of your overall monthly costs -- PITI, car payments, school bills, etc. -- and compare total costs with your monthly income, what lenders call the "back" ratio.

For instance, a lender might see that your front ratio is 28 and your back ratio is 36 -- a ratio which lenders would show as "28/36." Different loan programs have different ratio requirements, so ratios that might qualify a borrower for one program may not be sufficient for another and vice versa. Lenders will search through loan programs to find the plan which gives you the most dollars and best rates for your financial capacity.

Lenders also apply a common-sense test for capacity: If a borrower claims an annual income of $50,000 and a credit report shows $5,000 in monthly bills ($60,000 a year) then something is wrong. Underwriters will also want more documentation if someone is in a profession that typically pays $45,000 a year and claims earnings of $90,000 annually. It may be true, but it needs to be documented.

To support loan application claims, borrowers should have available W-2 forms, recent payroll stubs and tax returns for the past two or three years.

3. Capital

One great way to impress lenders is to have money in the bank, mutual funds, stock, savings accounts, IRAs and Keoghs. Having liquid assets means a borrower is better able to withstand a job loss, medical claim or other expense without missing a mortgage payment. More cash on hand means less lender risk -- and less lender risk means lower rates and access to bigger loans.

4. Collateral

Credit, capacity and capital reflect the financial standing of individual borrowers. However there's another C which is also important: "collateral" or the property which secures the loan.

The lender wants to be certain that the property has enough value to justify the loan, that the loan is just the right size and not too big. Lenders use appraisals to prevent what might be called over lending. Appraisals are a brake of sorts because lenders will only make loans on the basis of the sale price or appraised value -- whichever is less.

The importance of the four C's is this: Each "C" a by-product of borrower choices and actions. They can be controlled and improved by the borrower. In effect, you can begin to better your credit standing at any time and lower credit costs by handling money and bills the right way, the way that scores a solid "C".