Frequent references to the five C’s of lending are all over the internet, and it seems so mysterious.  But there is no need to go all Sherlock Holmes on the topic.  The five C’s of Mortgage loan lending are derived from pure common sense and are how the mortgage loan underwriters calculate the inherent risk of a lending transaction. 

The Following Five C’s Identified:

Character:  This commonly refers whether a borrower pays his or her bills on time, currently and in the past.  Lenders can check this information using a credit report on the borrowers.  Character also refers to the stability of the borrower, and is measured by length of time in residence, how long employed by one firm as well as how long employed in same industry.  So ask yourself, Do I pay my other creditors timely?  How stable am I?  have I kept my job for at least two years?  If not, why not?  The prospective lender finds this information documented in your credit report and by verification of corresponding fields on your URLA.  If one of these reflects badly on your lending risk, write a short note of explanation.

Capacity:  A borrower’s capacity is his or her financial fluidity, or ability to repay the loan.  Do you earn enough cash flow to cover both your current monthly obligations and the new mortgage payment(s) with room to spare?  Mortgage lending programs allow a range of debt to income ratios, or percentages.  Ideal, is a ratio of 43 percent total debt to income.  Keep in mind this is based on gross income, so the effective percent of your take home pay is higher.

Capital:  The amount of money you have or are investing into the property.  Do you have down payment money, closing costs and some reserves for unexpected repairs or events?  A purchase money mortgage loan has a much lower chance of default if the borrower is investing his or her own money into the transaction.

Conditions:  the specific terms of the loan that make it more attractive to a lender.  A lender would be more motivated to lend money to buy a car than to offer similar funds in a signature loan.  The latter could be used for anything and repayment is far riskier than repayment of the car that you need to get to work.

Collateral:  When you borrower money to buy a home, a mortgage lien is filed on the property.  This lien is the lender’s protection in case the borrower defaults on the loan note and the lender needs to recoup their losses.  Is the home value enough to cover the loan in case of default?  A real estate appraisal is usually required in a mortgage transaction to verify the home is worth as much or more than the loan amount. 

From a lenders point of view, having the five C’s in line, make the loan less risky.  An underwriter is quicker to give the mortgage loan approval.  From a borrower’s point of view, balanced loan decisions using the five C’s give protection against being stuck in a home that’s worth less than you owe or that costs more than you can afford.