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Orange County, CA: The 5 C’s of Home Lending

The 5 C's of Home LendingOgden Nash said “some debts are fun when you are acquiring them, but none are fun when you set about retiring them.” Isn’t that the truth with real estate! We all get excited to buy a home. It’s an emotionally charged event. It doesn’t matter if it’s your first home or your tenth investment property. The fact is, it’s fun acquiring homes even if debt comes with it. However, as with anything new, the excitement fades and new becomes routine. That’s when you see your debt for what it truly is…a liability. And paying off that debt is rarely fun. This is why lenders must be prudent when doling out the dough. They follow the time tested 5 C’s of home lending to determine if you are worthy of financing.

Before we dive into each of the 5C’s of home lending it’s important to get a glimpse of the lender’s perspective. A lender is issuing funds that they expect you to repay at some point in the future. A lender would not be in business very long if they made many loans that went unpaid. Defaulting borrowers are certain death for lenders. Therefore, they must implement specific measures to protect those funds. The first step is to screen and qualify each prospective borrower using the 5 C’s of home lending – Character, Cashflow, Capacity, Collateral & Credit. The next step is to secure the loan. With home mortgages, the security for the loan is the property. Simply put, if you don’t make your payments then you forfeit the property.

The first of the 5 C’s of home lending is Character. The lender wants to know if you’re trustworthy. What’s your reputation? Are you a good steward of money? This is the most subjective of the 5 C’s because character can’t be calculated. To do this the lender will analyze the consistency of your information, your attitude and your documentation. This will give them a gut feeling for your character. The lender wants to know that you’re credit worthy and if you’ll act in good faith should you get down on your luck.

The second of the 5 C’s of home lending is Cashflow. This measures if you have the ability to repay the debt by making the monthly payments. This is commonly referred to as debt servicing and is analyzed by your debt-to-income ratios. Debt-to-income ratios vary slightly from program to program. However, if you’re able to keep the payment for housing at or below 35% of your gross monthly income then you’ll be able to pass this part of the test. Keep in mind that lenders will also be looking at your total debt. To pass the cashflow metric completely you’ll need to keep your total debt at or below 55% for FHA & VA. For conventional loans the total debt ratios should be at 45% or less.

Capacity is the third metric. Capacity is the ability to repay debt on a timely basis and the probability of fulfilling the loan agreement. Lenders will evaluate your debt obligations and the nature of each. Do you have excessive inquiries? Is your existing credit individual or joint? How stable are you? Do you tend to change jobs or homes regularly? Do you have a good amount of experience in your field of work? These are all questions that are evaluated by a lender to determine your capacity.

Collateral is the fourth of the 5 C’s of home lending. An Orange County homeowner needs capital. Unless you’re eligible for a 100% VA loan, you’ll need to make some sort of initial investment. The capital requirement for a down payment can also be met with gifted funds from a relative, or other acceptable sources. Also, do you have sufficient reserves to cover any unforeseen bumps in the road? The more skin you have in the game and on the sidelines, the less likely you are to walk away from the home. And this is what the lender is looking for.

The last of the 5 C’s of home lending is Credit. Your credit score will tell a lot about your credit history. Each bureau, Equifax, Transunion and Experian will evaluate your credit and issue a score. The score is based on a myriad of variables. Some of the most important are the length of time that credit has been established, on-time payments, debt to credit limit ratios, number of credit inquiries, number of accounts and derogatory credit. Derogatory credit includes collections, liens, judgments, short sales, foreclosures and bankruptices. Generally speaking Orange County residents will need a minimum mid score of 600 or greater. The higher the better in the eyes of a lender.

Now that you understand the 5 C’s of home lending it’s time to set reasonable expectations. The lending industry has been transformed over the past 5 years. Credit and lending standards have tightened considerably. The lending pendulum has swung from the very lax left to the very conservative right. Home loans are more challenging than ever but they are getting closed. In fact, PrimeLending is on pace for a record year. It just means that you need to change your expectations of the process. You’ve heard the phrase, “it’s not personal, it’s business.” That’s the case here. Mark Greene sums up today’s lending environment pretty well in his article titled “The Perfect Loan File.” 

As a childhood hero of mine, G.I. Joe, always said – “Knowing is half the battle!” So don’t get overwhelmed, get educated. Through education we can release some of the anxiety that comes with acquiring a home loan in Orange County today. And in some cases, as Ogden Nash said, we can even have some fun!

Scott Storace

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