First time home buyers have many obstacles to overcome when purchasing their first home. Mortgage lending much like other lending is risk based and as such for a buyer to approach the application process uninformed could lead to a denial of credit. What are the factors that an underwriter looks for in approving a mortgage applicant? The short answer is “The four C’s” of residential lending which are collateral, capacity, capital and character. Avante Home Buyers has some nice tips on this.
In looking at most first time home buyers and going methodically through “The four C’s” of residential lending one wonders how a first time home buyer ever gets approved for a mortgage the first time. Let’s look at each one see how it may affect the first time home buyer.
Collateral. In a first time home buyer purchase, there typically is not too much collateral. Sure, in mortgage lending there will be a lien on the home, however most first time home buyers are purchasing with little or nothing down. The purchase price of the home is the market value so the first time home buyer is putting up little collateral. As such, the lender has an increased risk in the transaction.
Capacity. This is the ability to repay the mortgage. The first step is to determine the debt to income ratio. The underwriter will take all monthly debts and divide them by the borrower’s monthly income to determine what the debt to income ratio is. Also in determining the capacity, the underwriter will look at job history. Does the buyer hop from job to job or does the buyer stay put. A buyer who job hops may be a higher risk.
Capital. How much liquid assets does the borrower have? Stocks, bonds 401Ks, I.R.A.s, checking account balances and savings account balances all play a role in calculating the capital. The sum of these accounts is what is called reserves. Many times underwriters talk in terms of monthly reserves. Monthly reserves is referring the figure of taking the amount of reserves and dividing them by the monthly P.I.T.I. Six month reserves has become the standard in mortgage lending.
Character. One major factor in obtaining a mortgage loan is prior mortgage history. The first time home buyer is at a disadvantage here because there is no mortgage history. The next best thing to factor is rental history. The borrower’s credit history is looked at extensively to determine character. Delinquencies, proportion of balance to limits on installment and revolving credit, judgments and collections and bankruptcies all are looked at to determine character of the debtor. Also, the number of trade lines as well as the length of time the borrower has had each trade line is a determining factor. After all of these items are taken into account, the underwriter will look at payment shock. Payment shock is a measurement of how much the household expenses are increasing with the purchase of the home. If it is too big of an increase, the underwriter may deny the applicant despite whether the debt to income ratio meets the guidelines.