The 4 C's of Qualifying for a Mortgage

Whether you are a first-time homebuyers or are re-entering the housing market, qualifying for a mortgage can be intimidating. By learning what lenders look at when deciding whether to make a loan, you'll be more confident in navigating the mortgage application process.

Standards may differ from lender to lender, but there are four core components — the four C's — that lenders will evaluate in determining whether they will make a loan: capacity, capital, collateral and credit.

Capacity to Pay Back the Loan

Lenders look at your income, employment history, savings and monthly debt payments, and other financial obligations to make sure you have the means to comfortably take on a mortgage.

One of the ways lenders verify your income is by reviewing several years of your federal income tax returns and W-2’s, along with current pay stubs. They evaluate your income based on:

• The source and type of income (e.g., salaried, commission or self-employed).
• How long you've been receiving the income and whether it's been stable.
• How long that income is expected to continue into the future.

Lenders will also look at your recurring monthly debts or liabilities, such as:

• Car payments
• Student loans
• Credit card payments
• Personal loans
• Child support
• Alimony
• Other debts that you're obligated to pay

Capital

Lenders consider your readily available money and savings plus investments, properties and other assets that you could access fairly quickly for cash.

Having money saved or in investments that you can easily convert to cash, known as cash reserves, proves that you can manage your finances and have funds, in addition to your income, to pay the mortgage. Cash reserves might include:

• Savings
• Money market funds
• Other investments that can be converted to cash, such as individual retirement accounts (IRAs), certificates of deposit (CDs), stocks, bonds or 401(k) accounts

Along with cash reserves, other acceptable sources of capital might include:

• Gifts from family members.
• Down payment or closing cost assistance programs.
• Grants or matching funds programs.
• Sweat equity.

When you apply for a mortgage, the lender may need to verify the source of any large deposits in your bank account to ensure they're coming from an allowable source. That is, that you obtained the money legally and that it was not loaned to you.

Lenders may also look at the last two months of statements for your checking and savings accounts, money market accounts, or investment accounts to evaluate how much capital you have.

Collateral

Lenders consider the value of the property and other possessions that you're pledging as security against the loan.

In the case of a mortgage, the collateral is the home you're buying. If you don't pay your mortgage, the mortgage company could take possession of your home, known as foreclosure.

To determine the fair market value of the home you'd like to buy, during the homebuying process your lender will order an appraisal of the property that compares it to similar homes in the neighborhood.

Credit

Lenders check your credit score and history to assess your record of paying bills and other debts on time.

Many mortgages also have minimum credit score requirements. In addition, your credit score could dictate the interest rate you get on your loan and how much of a down payment will be required. 

Even if you are a renter, or don't have plans to buy right now, it's a good idea to get smart about credit and know ways you can build and maintain strong credit health.