The 5 C’s of Credit and how they affect your Mortgage Application
As you start looking to obtain a mortgage, it will be really helpful for you to have a good understanding of what brokers and bankers look for in your mortgage application. As we’re getting started as brokers, we learn about “the 5 C’s of Credit,” to help us understand our clients’ borrowing power. We wanted to write a quick blog post to help first time and repeat home buyers in Calgary understand some of the key things we’re looking for in a strong mortgage application.
The 5 C’s of credit are Character, Credit, Capacity, Capital and Collateral. We’ve broken them down for you below!
1. Character
When we’re presenting your file to the lender, we need to help them understand that you’re a trustworthy and reliable borrower. This it the first of the 5 C’s of credit, Character.
Is your credit in good standing? Does your credit report indicate that you’ve historically paid your bills on time? Does your credit report match your legal name, address and current employment? Is your net worth, (the amount of money you have in savings and investments), in line with your current stage of life? Do you have a little bit of a “rainy day” fund in the event your income was temporarily reduced or eliminated?
As the borrower, you should try to include as much true and accurate information as possible in your application. If any information turns out to be incorrect or inaccurate, it could have a negative impact on your application and approval process. We want you to tell us the whole story so that we can you frame the story in the best way for the lender and mitigate any risks.
2. Credit
This “Credit” section of the 5 C’s of credit is what you would expect, it’s a complete review of your credit bureau. The 2 major credit reporting agencies in Canada are Equifax and TransUnion. At Spire Mortgage Team, we typically start with Equifax as it’s more widely used by the lenders than the TransUnion reports. When we are looking at your credit report, we begin by cross referencing your current address and marital status with what was reported on your application. Next, we will look at any previous bankruptcies, consumer proposals, and collections, (let’s hope that there are none)! In Canada, without a bankruptcy or consumer proposal in the last 2 years and a credit score over 680, all borrowers should be able to achieve a triple A mortgage.
The quick rule for a great credit report is the rule of 2’s. We’re looking for at least 2 credit lines, (meaning a line of credit, credit card or car payment for example), with a LIMIT of at least $2,000 that have been in use for about 2 years.
Another quick trick about credit is that the lenders like to see your credit lines at no more than 65% of the limit. You’re better to have 2 cards at 50% of their limit than 1 card at 100% of it’s limit. Keep this in mind as you plan your spending.
If there are any negative marks on your credit report, let us know up front. Remember, the goal is to try and build a story to mitigate anything that could prevent you from getting your approval when you want to purchase your home.
3. Capacity
Capacity is all about your ability to repay your mortgage loan. How much money is coming in each month and how much money is going out? When we’re considering how much money is coming in, we’re going to ask these types of questions: How are you paid? Are you a salaried employee? Are you a business owner? Are you a commissioned worker? Do we need to consider your 2 year average income?
When we’re thinking about “what money is going out” we ask the questions: what other monthly debts do you have? Are you paying car payments? Student loans? Do you have lines of credit and credit cards that need to be paid off? Have you previously co-signed for a friend or family member’s loan?
The technical terms for the ratios that come from, “what funds are coming in and what funds are going out,” are called the “Total Debt Servicing Ratio and Gross Debt Servicing Ratio.”
The Total Debt Servicing Ratio takes into account all of your debts and all of your income. The rule of thumb is that no more than 44% of your total BEFORE TAX income should be spent servicing your debt. The Gross Debt Servicing Ratio takes into account only the payments related to your home purchase and the rule of thumb is that you shouldn’t be spending more than 39% of your BEFORE TAX income on your total housing costs.
4. Capital
This is the total amount of down payment invested in the deal. This means what percentage of the house price you’re putting down from your own resources. If you’re putting down LESS than 20% of the purchase price, your mortgage will require default mortgage insurance. If you’re putting down more than 20% of the purchase price, your mortgage will be “uninsured” or “conventional.”
Down payments must be confirmed with 90 days history of savings, whether it is coming from a savings or checking account, RSP, or investments. If the down payment is coming from the sale of an existing house, you will need to provide a firm agreement of purchase and sale, in addition to any schedules or amendments and a current mortgage statement. If the down payment is coming from a gift, a gift letter is required, along with the funds prior to closing. Some lenders also require proof of funds from the person providing the gift.
5. Collateral
Collateral is the only “C” of the 5 C’s of credit that isn’t really about you, as the borrower. This C is about the property. What kind of a property are you trying to purchase? Are you looking for a rural property? A single family home in a major urban centre? A condo? A mobile home? Are you thinking of building a new property? All of these questions will be taken into consideration as the lender considers the amount of money they are willing to loan against that property.
What does this matter? Because in the situation of a default on your payments, the collateral will provide a means of, at least, partial recovery. The straight goods are: if you can’t pay the mortgage, the lender will take the home and try to sell it to recover the mortgage funds they lent you. This means that they REALLY care about the marketability of your property. If you’re purchasing an obscure property that could be difficult to sell in the future, the lender will require a greater down payment to offset the marketability risk. If you’re purchasing a property in a major urban centre that would sell easily to a wide range of other home buyers, then the lender will be willing to proceed with a lower down payment amount because they are comfortable with the home as “collateral.”
Summary
Overall, if one or more of the “C’s” needs a little work, this doesn’t necessarily mean your mortgage is a no-go. We will always take a look at the overall picture, and address any discrepancies, and work with you to mitigate any concerns. The key thing is to make sure that when you’re thinking about a home purchase you obtain a comprehensive pre-approval from an experienced mortgage broker. We will help you sort through the “5 C’s” and make sure that we’ve set you on the path to making any improvements BEFORE you start to negotiate on a property.
