Credit Basics You Should Know

There are 5 different characteristics that determine the likelihood of a bank lending you money. The following “5 C’s of Credit” are evaluated every time a lender considers extending somebody a loan. Get to know the following credit basics to keep your credit standing strong.

Character is the general impression you make on the lender.  The lender is interested in knowing how responsible you will be as a borrower.  In making this determination, they will look at your employment history, how long you have been at your current residence, and your credit report.  Your credit report cannot objectively determine your character but it has been found that people who work hard in the same line of work, have a higher education level, and tend to stay at their residence longer, are more likely to pay their loan on time. 

Collateral in a real estate transaction is the home you are purchasing or refinancing and the land it sits on in most all cases.  The lender wants to be certain that the money they are lending against your property can be recouped if for some reason you were unable to pay your mortgage. An appraisal is usually required in a mortgage transaction to ensure the property has the value the lender is looking for. An appraisal will also identify any deficiencies in the property that might make it difficult for the bank to sell should they need to. 

Capital is the money you have invested in your purchase or the money you have accumulated as equity in a property you already own.  Capital also refers to the amount of money you have been able to save.  Assets such as checking, savings, and retirement accounts also add to your net worth. These assets account for reserves that could be used for mortgage payments should you ever need extra money.  Lenders look favorably on people who have higher capital investments in properties and higher reserves.

Credit is your history of repayment on various types of loans.  Your credit history is kept on file at the credit bureaus for several years.  Car loans, mortgages, credit cards, and lines of credit are all items that a person needs to make sure are paid on time.  Your history of payments as well as how you use your credit determines your credit score; a number between 350 and 850 that a lender uses as a large factor in determining your ability to repay a loan.

Capacity is the main criteria in determining how likely it is that a person will repay a loan. It is typically the most important factor in obtaining a mortgage. A lender will look at your debt to income ratio and see if you have the ability to make the payment.  If you have a low debt to income ratio of say, 38%, it is very likely you can repay your loan.  If your ratio is higher…let’s say 55%, a lender will question your ability to repay.

Debt to Income can be calculated by taking your existing minimum monthly debt obligation payments plus the new mortgage payment, and dividing that number by your gross monthly income. 

Example: 

$2500 total debt payments per month / $6000 gross monthly income = 41.6% Debt To Income

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