I started my first job working for a finance company way back in 1984.
If my memory serves me correctly, it was on either the second or third day that I was first told about the 4 C’s of lending.
Now, whilst the whole finance market has changed radically since then, the fundamentals of how a lender will assess an application hasn’t. The tools they use are far more sophisticated, but the thinking behind it is the same.
Understanding these fundamentals (and ensuring you have these areas in order) will help you prepare for a home loan.
Let’s take a look at them.
- Capacity to repay the loan
- Credit history
- Collateral (Loan security)
- Current conditions
1. Capacity to Repay the Loan
Without capacity to repay the loan nothing else matters.
This ‘C’, is all about proving to the lender that you can comfortably make the repayments based on your current income and expenses. You need to prove to the lender that you have, and will continue to have, the financial capacity to service the debt without hardship.
A credit assessor will:
- Look at where your income is derived from
- What expenses you have, and then
- Calculate what surplus there will be to service the loan you are applying for.
Each lender will have their own way of working this out which leads to different maximum borrowing capacities across different lenders.
2. Credit History
A credit assessor will also look carefully at your repayment history.
The analyst will access your credit file (with the past five years history) and look at both the lenders and the frequency of enquiry on your file for evidence of who you borrowed money from, and how responsible you have been in meeting repayments.
If there is anything in your credit file that looks less than rosy it’s very important to explain this to your mortgage broker. This way he or she can paint your history to the credit analyst in the most positive light, and mitigate the impact of any shortcomings in your file. For example: if your credit file shows that you were late with your credit card repayments for three months running, and this was due to illness or loss of your job, your mortgage broker can explain this to the credit analyst.
3. Collateral (Security)
Collateral is all about the security you can offer the lender.
The credit analyst will look at the proposed security for the loan and determine first of all whether they are happy to lend against it, and secondly what percentage of the value of the property they are willing to use.
A home in the suburbs will be attractive to all lenders, and sometimes you will be able to borrow up to 95% of the value of this property – this is known as the Loan to Value Ratio (LVR). By contrast “unusual security” will have a potentially lower maximum LVR. Some security properties that may be affected are: acreage properties, very small apartments, inner city apartments in certain areas or commercial or mixed zoned properties. Again, this is where we will see large differences between lenders on what they are comfortable to lend against.
4. Current Conditions
This last ‘C’ is not so straight forward. It is more of a catch all for anything the lender wants to take into account.
The credit analyst may look at the industry you work in. For example, if you work in the car or mining industries this may mean they are more cautious. Or, if you are an older borrower, they will look to see if you will be able to continue servicing the loan after retirement through savings or superannuation.
These 4 C’s are universally used by all lenders to assess loan applications, however they can be applied differently from lender to lender. The more knowledgeable you are about how loan applications are assessed, the better able you will be to present your credit history, assets, liabilities and current circumstances in the best possible light.
Speak to your mortgage broker who can explain the process credit assessors follow in further detail and help you through this process.