Mortgage lenders will evaluate the 5 C’s of credit to determine the creditworthiness, or one’s ability to repay a debt obligation, of a borrower.
What are the 5 C’s of Credit?
The 5 C’s of credit include character, capacity, capital, collateral, and conditions. We outline and explain each below.
Character refers to the information presented in your credit report, which includes your overall ability to repay debts, employment history, and your lines of credit. Reviewing this information helps the lender better understand how you have handled past debt obligations and show you are trustworthy and reliable borrowers.
Capacity also refers to “cash flow.” This helps the lender understand if you have the power or proper cash flow to repay the loan. Your debt-to-income ratio will help the lender determine your ability to repay. The lender must ensure that the mortgage loan will not make your debt-to-income ratio exceed a certain level.
The amount of capital, or down payment size, refers to the amount of money you plan to put towards the house. Putting more money down towards the home may alleviate some of the potential risks associated with the loan. Also, having more capital or higher down payment may help you qualify for a lower rate or more favorable loan program.
Collateral refers to personal assets, such as the home or other assets used to guarantee or secure a loan. This ensures that if you were to default on the loan, the lender could rely on the asset to recoup the losses.
Conditions may involve factors related to the loan, such as the loan program and interest rate, and external factors such as the economy and industry trends. Right now, lenders are taking extra steps and precautions to verify employment, given the current state of the employment market.
Why are the 5 C’s of Credit Important?
The components of the 5 C’s of credit help the lender better understand your overall financial profile and help the borrower better prepare for the homebuying process. If you have some recent late payments on your credit report, you may want to focus on making timely payments before applying for the loan. Or, if you do not have enough money for a down payment, you may want to focus on saving up for a few months before getting pre-approved.
If you are interested in learning more about the 5 C’s of credit or speaking with one of our mortgage specialists, click here.