Most Lenders consider 4 vital facts before giving you a
residential mortgage:
The four C's
-
Collateral. The value of the property you are
borrowing against.
-
Credit. The way you have paid people in the past
is considered a good indication of your willingness to pay money back in the
future. 75% or more of loan originations involve the use of FICO
credit scores
- Capacity.
Do you have the income to pay this loan and still eat!
- Commitment. How
much of a cash down payment did you put down.
Why are these 4 things important?
Real estate collateral or
Loan to Value ratio
Your
mortgage will typically be a proportion of the value of the real estate. For
example: the home has a market value of $100,000 and you want to borrow $80,000
as a first mortgage. This would be a Loan to Value ratio of 80%.
Let
us assume for the moment that you are buying the house for full market value,
that is $100,000. Where does the rest of the money come from, $20,000 plus the
closing costs, pre-paids etc? It could come from your savings, it could come
from a second mortgage, either a seller held second mortgage or another lender,
it could come from a gift, perhaps from your parents. Or it could be a
combination of these.
Lenders
LIKE you to have your own money in the deal. If the other 20% is your money,
this gives them a strong feeling of security.
How
about if you are actually buying this $100,000 house for $70,000? Conventional
lenders like banks will only lend you 80% of the market value or purchase price,
whichever is LOWER. In this case they would lend you 80% of $70,000, or $56,000
Why
is this? It makes the loan safer for them, they don't really believe that you
have got a great deal and they still want you to have your money in the deal.
But
there are mortgage lenders, typically those that work with investors who will
not be bound by a percentage of the purchase price. However they will usually
lend you less than 80% of the appraisal value. These lenders are often called
hard money lenders.
Why
is the Loan to Value ratio important? Simple. If the lender has to foreclose on
the loan because the borrower hasn't paid, they will not only want to recover
the principal outstanding, but also their legal fees and unpaid interest.
Obviously this can only happen if the house is worth more than the
principal, legal fees and accrued interest. If they lent $100,000 against a home
worth $100,000 this is not likely to be the case!
Credit
If
you have a proven history of not paying other people on time, it is highly
likely you won't pay the lender on time. Let's be blunt here. When someone has
bad credit, what it really means is they just don't pay their bills. Now there
can be a good reason for this, and these are often taken into account. For
example medical bills when someone has no health insurance. Or perhaps you went
through a nasty divorce and your bank account was cleaned out. Maybe you started
a business that failed and have now got a regular job.
But
if there is a track record of car repossessions, credit card write-offs, unpaid
utility bills etc. you come across as someone who is financially irresponsible.
Unless the property is worth a lot more than the loan you want, you probably
won't get it.
Capacity
The
lender wants to sure that you can afford to pay your mortgage and still pay your
other bills. In fact, it is LAW in some states that lenders avoid residential
loans that the borrower clearly can't afford. They will consider your job
history and your time on job. How much other debt do you have? Are you over
extended? Conventional lenders use certain ratios to calculate your capacity to
pay back the loan. A conventional lender is one like Bank of America,
Wachovia, Wells Fargo Bank.
Commitment
Commitment
is usually shown by having your own money at risk. If you are buying a $100,000
home and put down an investment yourself of $20,000 you have made a big
commitment and will not lightly walk away from your obligations. On the other
hand, if you have none or little of your own money invested, you are much more
likely to just shrug your shoulders if things get tough and walk away from your
obligations.
Consistently,
year after year, low down payment FHA mortgages loans have a higher default rate
than conventional mortgage loans.
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