During the loan approval process, lenders look at three factors: credit, capacity and collateral - informally known as the Three Cs of Underwriting.
To analyze these factors, lenders may pull your traditional and alternative credit reports, employment history, bank account information and other details. Let's take a closer look.
With respect to credit, mortgage lenders assess the following details:
- Your credit score (could be from one of the three major credit bureaus or an alternative credit bureau).
- Any foreclosures, bankruptcies, liens and/or judgments you have in your name.
- Mortgage delinquencies you've incurred in the past.
- Whether you've fallen behind on credit card or loan payments.
- If collection agencies have had to repossess items for which you had taken out a loan.
- Credit account details (type, age, limits, usage and status).
- Your requests for new credit in the 12 months before you submitted your application.
Depending on the length of your credit history, the lender may not be able to access some of these details. If that's the case, you can let them know you have an alternative credit report, which they can access online. This report will show them that you've paid your utilities, rent and other monthly expenses on time and in full, increasing your chances of getting approved.
"Your debt ratio is the total amount of debt you have divided by your total assets."
Your Capacity to Repay
"Capacity" refers to your ability to pay back a loan. A key part of the loan approval process, lenders will review your debt ratios, monthly income, cash reserves and how the loan is structured.
Your debt ratio is the total amount of debt you have divided by your total assets. Essentially, if you have a high debt ratio, it means you owe creditors more money than what you actually own.
Let's say you took out a $12,000 car loan, and still have to pay off $6,000. At the same time, you have $14,000 in savings. That means your debt ratio is 42 percent, assuming you don't have any other outstanding debt.
What's your total equity? How much are putting as a down payment? What type of property are you buying? A one-unit or condominium?
These are the types of questions lenders ask regarding collateral. Basically, if you default on your loan, the bank wants to know whether the value of your house will compensate them for their loss. Lenders don't want to get stuck with a house they can't get off the market.
That's pretty much the gist of if. If you want to learn more about the loan approval process, check out how you can use alternative credit reports to apply for home loans.