Every 1st Time Home Buyer and the 5 C’s of Credit

Although the numbers of homes for sale have plummeted during the coronavirus outbreak, it also may represent an opportunity to buy the home of your dreams.

The following are the 5 C’s that every first-time homebuyer should know:

THE 5 C’S OF CREDIT

1. Character
2. Capacity
3. Capital
4. Collateral
5. Conditions

Today, “character is often measured by your credit,” says Benjamin Keys, assistant professor of real estate at the Wharton School of the University of Pennsylvania. “And credit scores are a key metric.” Everyone’s credit reports contain information about their credit accounts. Any lender can look at your credit reports to learn how often you make payments on time and how many accounts (credit cards, auto loans, student loans, etc.) you have in good standing.

Your credit score is the three-digit number that reflects the information in your corresponding credit report. Knowing what goes into your credit scores and reports can be the first step to improving them so that you can make a good impression on potential mortgage lenders.

“Capacity” is based on your ability to financially repay the mortgage. This metric is based on income and employment. Lenders will review your most recent federal tax return, consecutive pay stubs and a few months of bank statements to verify your income. Most lenders will want to see proof that your income is stable and consistent. Lenders may also look at your Debt To Income ratio (DTI). This allows a lender to evaluate how much additional debt you can handle and how much of a credit risk you pose.

“Capital” is the money you may have left after buying a home. This would include any investments, properties, and any other assets that could be liquidated for cash quickly. This is important because lenders would prefer you not clean out your bank account to buy a home. Sometimes they’ll prefer to see how many months of mortgage payments you have in the bank when you’re negotiating the loan.

“Collateral” is something of value that secures a loan. When you get a mortgage, the collateral is typically the home itself. The collateral is basically what the lender is depending on in the event the borrower defaults and can’t pay back the mortgage loan. This is one of the reasons lenders typically require a home appraisal (and sometimes an inspection also) is to be sure that the house’s value supports the amount of the mortgage.

And finally there’s “Conditions.” The fifth C examines the prevailing market conditions to your home purchase. While the other four C’s are personal to you, this fifth C is the factors influencing the larger picture at play. “Conditions” can include everything from interest rates and mortgage rates to cost of living and how many homes are on the market in your specific area. Bear in mind that all real estate market is very local. It helps to understand what the supply-and-demand situation is in the area and price ranges that you’re targeting. In a “buyer’s market,” where supply exceeds demand, you may have more leverage to bargain with because there are lots of houses available, so it can become more difficult for sellers. Conversely, in a “seller’s market,” where the demand exceeds supply, the seller may have the upper hand.

But knowing the five C’s of credit can also give you confidence at a crucial time. (Sort of like having the exam questions in advance for the big test.) You can use them to help you prepare, shop smart, and select the home and mortgage that will best fit your life and your finances.

Having a clear understanding of the five C’s of credit can also give you confidence at a critical time. Use these tips to help you prepare, shop smart, and select the home and mortgage that will best fit your finances and dream of home ownership.

Contact one of our loan consultants to learn more.