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What Lenders See in Credit Scores

Dec 5 2019

C is for credit score, and so much more …

The closer you get to buying a home, the more you’re likely wondering: What does my credit score determine?

When you apply for a mortgage, lenders look at the whole picture. They analyze your entire credit report, of which your FICO score is just one facet. Having “good credit” presents you as a low-risk candidate for a loan as it shows lenders that you are good at managing debt. Typically, the better your report and score are, the more mortgage options you’ll have and the lower your interest rate will be. But what makes credit look good to lenders? They look at four main factors, called “The Four C’s”:

1. Capital

Capital is the cash you have ready to put toward the purchase price and closing costs for the home you’re buying. Closing costs are the administrative fees and other charges that are paid at closing. They normally total 3% to 6% of the loan amount and should be planned for and saved as early as possible. Lenders like to see that you already have all the capital you’ll need, whether it be from savings, gifts, grants, or special programs.

Regarding your down payment, the bigger it is, the less you’ll need to borrow (and the lower your monthly mortgage payments will be). Lenders verify the source of your down payment and your history of savings. If a friend or family member plans to help you with your down payment, they may need to sign a gift letter and demonstrate that they really do have the money to give you. On top of savings for the above, both you and your lender will be more comfortable if you have some extra money to spare – whether it be for an unexpected gap in your income, moving costs, or the various expenses incurred when buying a home. Some lenders actually require safety cushion funds.

2. Capacity

Your “capacity” is your monthly income and how stable it is. Can it safely cover a mortgage and home expenses? To determine this, lenders review your income, employment history, and earning potential. The standard for stable income is two years with the same employer or in the same field. If your income varies from month to month or year to year, you’ll probably need additional proof that you’ll be able to afford to own a home.

3. Credit history

Your credit history shows what you’ve borrowed and paid in the past. It demonstrates to lenders whether you tend to spend more than you earn and if you are reliable in paying bills on time. Lenders typically require 12 to 18 months of positive history that shows modest balances, no late or missed payments, and other conditions. Your credit score is one number that sums your overall credit history.

4. Collateral

Unlike the first three Cs, which are based on you, the fourth relates to your future home. Lenders have the right to take possession of (or foreclose on) it if you default on your mortgage, so they have the property appraised to find out what it’s worth. The official appraisal value of the home is your collateral.

We hope this made you feel a little more prepared to have a lender inspect your credit during the homebuying process. For more information on credit scores, check out:

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