First-Time Buyers: Do You Know the 5 Cs of Credit?

Buying a house comes with a lot of considerations for anyone and especially first time home buyers looking to get into the housing market.  Usually, home buyers put a lot of thought into how they can afford a home but often forget about building creditworthiness or ensuring that they are a worthwhile risk for a lender. 

  1. Capacity
    From a lender's perspective, capacity is a borrower's ability to repay a loan and comes down to largely your income versus expenditures or other debt obligations.  Some lenders may take your current income and project it decades into the future to see how your income will change over the time you have your loan.  

    Capacity also deals with your cash flow which can raise a big red flag if you spend unnecessarily or have considerable debt obligations elsewhere.  One way to improve your capacity as a borrower is to pay off any debts (especially credit cards) and make a conscious effort to be less of a debt burden to your lender.
  2. Collateral
    Collateral, unlike capacity, deals with the purchase you're about to make (i.e., your new home).  In other words, does the price you plan on purchasing your home for appraise for that price?  If the appraisal of your home falls woefully short of the price you plan on paying or what you've contracted for, then the bank may not have adequate payment in the event you default.

    One way you can protect yourself in this area of credit is to make sure the home you're buying is in good, livable condition with no obvious signs of value-damaging issues such as termites, structural flaws, or anything else that could muck up potential reselling.
  3. Character
    For the most part, character comes down to how you pay you to manage your money and how faithful you are to your debts.  Do you pay your debts, child support, rent, car payments, and other financial obligations on time and in full?  How likely are you to repay a mortgage if it were lent to you?

    These questions evaluate what type of person you are and how much of a risk you are to default on a large loan.  For the most part, if you've had a spotless history of repayment and faithfulness in making payments towards your required financial obligations, this will be the least of your concerns.
  4. Capital
    This examines how much money you have available for a down payment and may make a huge difference if you're deficient in another area of the 5 Cs.  For example, maybe you rate poorly on capacity or another criterion but are willing to make a substantial down payment.  

    Capital shows not only how much you have available towards your home but how much proverbial "skin in the game" you're willing to put forth.  A large down payment can display commitment and character to your lender.
  5. Conditions
    Finally, what are the market conditions in your area?  Are they likely to degrade or improve?  This helps your lender decide whether or not they can make up enough of the difference of your loan in the event you default on your mortgage.

    While no one buys a house with intentions of default, it does happen, and lenders must protect themselves if it does.  You can help smooth over the conditions aspect of your mortgage by sitting down with your lender and discussing your financial situation and together find the right financial solution for a mortgage.