Early in our finance career we are told about the 4 C’s of lending.
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:
a) Check your income
A credit assessor will look at how much income you have and where it came from.
b) Review your expenses
Now, more than ever before, banks scrutinise a borrowers living expenses to ensure that what has been declared is what is being spent. Be prepared if you have had a big month (or months) of expenses to explain why those expenses are one off costs and are not likely to continue going forward. Some lenders are more intense than others. Living expenses include transport, groceries, internet, insurances, pay tv, child care maintenance utilities, rental property costs. They will verify this from your last 6 months bank statements.
c) Do you have a a surplus?
A credit assessor will take their estimate of your income and subtract their estimate of your expenses to determine if you have a surplus 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 us and we can explain the process credit assessors follow in further detail and help you through this process.