Your application is evaluated based on the RISK that you represent to the lender. RISK to the lender is the only real criteria that is considered when they review your loan qualifications. When you begin to understand that the RISK of losing money is any mortgage lender’s primary concern, mortgage lending starts to become very easy to understand.
An easy way to remember the criteria that lenders use to evaluate your loan application is the “3 C’s”, Credit, Capacity and Collateral.
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Since they can’t read the future, they can’t really know if you will make your mortgage payments on time or not.
However, research has shown that the best way to predict your FUTURE “on-time payment performance” is to review your PAST payment performance. That’s why your credit report it so important. It allows them to get a very complete picture of your outstanding debt obligations, your on-time payment track record, your credit mix and details about any other monies owed. Collections, judgements, etc.
Understanding your credit profile does not eliminate their risk. You might still default in the future even though you’ve been perfect in the past.
However, it does minimize their RISK.
… or funds from other approved sources. Capacity is your financial ability to perform on your commitment. The lender wants to make sure that you have enough money for your required down payment and/or closing costs.
They also want to minimize their RISK by better understanding your reserves, that is, the money that you will have leftover after the transaction is complete. In the case of financial challenge, they want to make sure that you are stable enough so that you can weather a “financial storm”.
The amount of money that you pay towards the following items can reduce your tax basis:
… is the last “C”. Collateral is extremely important because it is a lenders last resort to get their money back in the event that the borrower defaults on their loan.
When you borrow money, you offer a Deed of Trust to the lender that gives them the right to take ownership of the property if you default on their loan. The vehicle that they will use to do this is called foreclosure.
Since the loan is being secured by the property as collateral, the lender wants to be extremely confident about the value of the property. The document that helps them to determine value is called an appraisal, and it it required for nearly every home loan.
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