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Do You Know Your 3 Cs?

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Posted On: 02/17/2016

QUESTION:

We spoke with a loan officer who said our mortgage application would be a success because we did well with “the three Cs.” This is code to us. What are the three Cs?

ANSWER:

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Every business has shortcuts and that’s true with lending. Some lenders will tell you about the three Cs and some look for the five Cs – which, of course, is two Cs better!

Let’s start with the three Cs: character, capacity and capital.

By character, lenders mean the manner in which you have used credit in the past – your credit history. The two main indicators of character are your credit report and credit score. You need a good credit report to generate a solid credit score. It’s a good habit to review your credit report at least once a year to get rid of any old information or factual errors.

Capacity represents your ability to repay a loan. It takes a certain amount of financial heft to carry debt such as a

mortgage. The best index of capacity is your debt-to-income ratio. The DTI is expressed as a percentage: your total recurring monthly debt, such as mortgage payments, car loans, student loan payments and credit card bills, divided by your gross monthly income.

Generally, a desirable DTI is less than 43 percent; the lower the better. For example, if your gross household income is $7,000 a month and you spend $2,800 on recurring bills, you have a 40 percent DTI.

Capital is the third C. Lenders want to know that if something goes wrong – if you lose your job, say – you will continue to make your monthly payments. Capital can include cash in checking or savings accounts, mutual fund balances and retirement account assets.

Those are the three basic Cs. Sometimes lenders add two more.

In the world of lending there are secured and unsecured loans. An unsecured loan can be a personal debt, such as a credit card advance, while a secured debt involves a loan tied to an asset. That asset serves as collateral for the loan – the fourth C.

For example, your home is security for a mortgage. If you really got into trouble you could sell the home and hopefully it would yield enough cash to pay off the mortgage. That’s not a great choice, but it’s better than a foreclosure, the loss of your credit standing and in some states maybe even a suit by the lender to recover any unpaid loan balance.

The fifth C concerns conditions. Basically, the lender wants to know what you intend to do with the money. You say you want the money for a house? Good – that’s a secured loan we can tie to the appraisal of the house.

You want the money for a business? Maybe. How much of your own cash are you putting in?

You say you want the money for a few trips to the casino? No thank you, but good luck!

Peter G. Miller is the author of The Common-Sense Mortgage and a veteran real estate columnist. Have a question? Please write to peter@ctwfeatures.com.

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