There’s a lot to know before you buy a house but today we’re here to tell you about the 5 C’s of credit: Character, Capacity, Capital, Collateral, and Conditions. These 5 C’s together come together for one more important C we’ll tell you about later!
When somebody asks to borrow your stuff you probably stop to ask yourself if this is someone you can trust. In other words, you determine what kind of character this person has. Lenders do the same thing before agreeing to lend you money for your mortgage. Since they don’t know you personally they find out what kind of financial character you have by looking at your credit history.
Many companies send credit reports to Equifax and TransUnion. Companies that provide credit products send these kind of reports, as do companies that provide cell phone and utilities services.
When you give a lender permission they can look at your payment history and find out your credit score, a number between 300 and 900. You should also get this information for yourself so that you know where you stand and what you can do to improve your chances of working with potential lenders.
- Get your credit reports You can get these from Equifax or TransUnion. Take the time to review your credit history. Be sure to report any incorrect or suspicious reports or accounts.
- Check your credit scores Each company uses its own algorithm to determine your credit score so it is important that you be familiar with both. Most mortgage companies will use your Equifax score but they will also look at your TransUnion score. Either way, it’s important to know what position you’re in.
- Talk with the lenders Many lenders will group credit scores into tiers. The better your score the better your mortgage options and interest rates. If it turns out your credit score is just a few points away from a better tier it is probably worth it to take the time to improve your credit before applying for your mortgage.
Capacity is your income compared with your debt. Lenders use this comparison to determine how much mortgage you are capable of paying for. They will use your most recent tax return as well as a few recent pay stubs to get your income information and they will also take into consideration how long you’ve been working at your current place of employment.
Lenders will then look at your Total Debt Service ratio. This is a total of all your monthly debt payments divided by your total monthly pre-tax income. This ratio is important to potential lenders because it helps them know how much additional debt you are capable of taking on. Not only is your TDS used to determine your credit score but it also affects your ability to qualify for credit products like a mortgage.
To calculate your own TDS ratio start by adding up your monthly debt payments. This includes things like credit cards, lines of credit, vehicle payments, and other loans. Then divide the total by your gross monthly income. Your TDS should not be higher than 44%. Take into consideration that after you get a mortgage your TDS will be even higher.
- Lower your TDS If you expect your TDS is going to be higher than 44% after you get a mortgage it’s a good idea to try to lower it beforehand. You can do this by increasing your income or decreasing your debt.
- Increase your savings A high TDS can be compensated for with a large savings or other liquid assets.
- Decrease your purchase price If you want to avoid sending your TDS into the stratosphere consider buying a cheaper home than you originally planned.
- Do your research Make sure you know what the costs of homeownership will be above and beyond your mortgage. Learn more here about all the expenses you can expect.
Capital is what you have in the way of savings, investments, assets, and properties. Lenders want to know you’ve got some money stashed away and will be able to keep paying your mortgage even if you come on hard times. That’s why it’s important not to pour your entire savings into your down payment.
- Ask for the lender’s expectations Find out how much capital your lender wants you to have.
- Reassure yourself It’s important that you also feel secure after the purchase of your home. Do some budgeting and ask yourself honestly how big you need your “rainy day” fund to be.
Collateral is what you promise to give the lender if you can’t pay back the mortgage. In most cases the home itself is put up as collateral, which means a home inspection will be done. However, if you only put down 5% on your home you will be required to pay CMHC (Canadian Mortgage and Housing Corporation) home insurance and an inspection will probably not be done. If you want to avoid paying this insurance your down payment will have to be at least 20%.
- Ask for requirements Whether you end up using CMHC insurance, get help from a down payment program, or end up with a typical mortgage, find out what your lender wants from you as collateral.
The 5th C in our list is different from the previous 4 because it is completely out of your control. Conditions include things like supply and demand, the cost of living, and interest rates. The only power you have here is to do your research so that you know you’re getting the best deal available.
- Start with a pre-approval A mortgage pre-approval is an application sent to lenders. In return they give you a rundown about how much money they’re willing to lend you and at what rate of interest. Each time you submit a pre-approval it counts as a soft hit to your credit because each lender will review your credit history. Your best option is to work with a mortgage broker who will check your credit once and send your information out to multiple lenders simultaneously.
- Research lender options You might think the only place to get a mortgage is a big bank but there are many other options available. These include small banks, credit unions and mortgage companies. Do your research and find the best fit for your needs.
When you use these 5 C’s of credit together you end up with another C; Confidence! For more information or to get started with a mortgage broker contact us today!