The Five ‘C’s of Credit – What lenders look for in a mortgage application
Regardless of where you seek funding - from a bank, a non bank lender, a building society or any credit provider - the prospective lender will always review your creditworthiness prior to making a decision as to whether your loan application will be ‘approved’.
All questions that are found in a mortgage application are ‘always’ motivated towards obtaining information that will give the lender a solid understanding of your creditworthiness.
The "Five C's" of credit are the basic components of any credit analysis. The 5 ‘C’s are described here to give you an insight into what a lender is thinking and what the key issues that will be assessed.
Capacity
The capacity to repay a mortgage is the most critical of the five credit factors.
Any prospective lender will want to know exactly, how you intend to repay the loan and from what income source(s).
If you are employed, it is a relatively simple task to identify how much you earn, irrespective as to whether you are employed on a full time, part time, causal or on contract basis.
The lender merely has to confirm this information with your employer or through other documents such as Group Certificates, or computer generated payslips that show the number of hours worked, year to date income earned and other information that the lender requires.
Tip: If you are currently employed and wish to change jobs, it would be wise to consider your finance arrangements before making any loan commitment. Many people have been ‘caught out’ by finding it very difficult to obtain an appropriate mortgage, when applying just after changing jobs.
Often, lenders will not approve a loan if you have recently changed jobs due to concerns of ‘job stability’. The simple advice here is, seek advice before you commit.
Other sources of income such as overtime, bonuses, centrelink, investment income, rents etc may or may not be acceptable for various lenders credit policy. Often, accepting this income for the purposes of loan repayments will be dependent on how long you have sourced this income and whether it is regular or not.
Simply speaking, different lenders have different policies as to what income they will accept, which is why there is a broad range of maximum loan sizes available from lenders to the same applicant.
Tip: A rough rule of thumb for employed borrowers, as to their borrowing ‘capacity’ is based on a multiple of around 4.5 to 7 times income.
So if someone earns say, $65,000 p.a. then they could borrow approximately $292,500 to $455,000 dependant on other debts & financial commitments.
For those that are self employed, identifying income can be a difficult proposition.
Historically, lenders required a self employed individual to provide ‘full financials’ with their application and for the business to have been operating for at least 2 years.
This meant that for ‘self employed’ borrowers seeking mortgage finance, the task was extremely tough. Start up business’s often had to ‘tough it out’ with little capital, as they were often, ineligible to borrow.
More mature businesses also had to provide adequate financials to demonstrate the capacity for the applicant to ‘service’ (pay) the prospective debt.
In more recent times, more flexible ‘product development’ structures have allowed self employed borrowers to simply ‘declare’ their income or in some cases, to only acknowledge their capacity to service the debt.
To the lay person, for lenders to adopt this approach seems simply foolhardy.
Perhaps, but lending standards in Australia still reflect low ‘bad debt write-offs’ and sound prudential regulation when compared to similar industries overseas.
In any event, the issue of ‘capacity’ to repay is as important to lenders today as it ever was. To know where you stand with your income as it relates to borrowing capacity, call Assent Mortgage Finance now on 1300 72 86 96 to discuss.
Credit
The second ‘C’ of credit analysis is all about your credit history.
Consumer & small business credit history records in Australia are still a very basic system of ‘event’ recording.
Of the few credit reporting bureaus operating in Australia, the leading bureau merely provides lists of ‘events’ There is no interpretation or assessment provided, simply a credit report that shows
- Consumer Credit enquires
- Credit defaults
- Legal Actions
- Directorships & Proprietorships
- Bankruptcies
There is some additional information provided, but in essence this is it.
For many borrowers, a surprising observation is that they don’t have a ‘credit rating’ as such. Essentially there is no such thing as a Credit Rating in Australia for consumers.
However, you will have a credit record that shows;
- No credit history (if you are a new arrival to Australia or are borrowing for the first time)
- A credit history with no ‘adverse’ entries noted or
- A credit history with one or more adverse credit entries
Now, the key issue for any borrower is to understand what lenders are looking for when they review your credit file.
Having No credit history can be frustrating in some circumstances, but this problem generally impacts on borrowers intending to obtain ‘unsecured’ loans (personal loans, car loans etc). For secured loans (like mortgages) having no credit history is of little relevance, unless it conflicts with other information that is available to a lender.
A credit history with no adverse entries allows the borrower a fairly free hand at the choice of lender and product available from the entire lending community. Lenders call these applicants ‘clean’ and are the most desired borrower type.
If a borrower has good income, significant assets, low debt levels and a ‘clean’ credit history, then this credit ‘profile’ is the most preferred borrower type and implies a low risk of any future default or loss for the lender.
It doesn’t guarantee it, but it looks good.
An ‘adverse’ credit history is an area which catches many borrowers out.
If you have a ‘poor’ credit history, this could mean different things to different lenders. For some lenders, having a number of unpaid defaults, may not necessarily mean you cannot obtain a mortgage. It simply means that the number of lenders that will look at you application is reduced.
Most lenders try to understand your application and the reasons for any credit default, but that does not mean that you are guaranteed to obtain a mortgage with any lender you choose.
There are perhaps around 100 residential mortgage lenders including banks, building societies, non bank lenders etc, and every one of them have a different attitude to how they will deal with any adverse credit found in your credit report.
Collateral
Simply put, collateral refers to an asset or assets that a lender ‘secures’ by way of a mortgage to protect themselves in the event of borrower loan default.
As far as mortgage finance is concerned, collateral relates to real property security. This could mean Residential, Industrial, Commercial, Rural, Vacant land etc. Practically anything that has a Title Deed.
The collateral provided by a borrower provides a lender with the ‘security’ necessary to hedge against a borrower defaulting on a loan.
More often than not, a security is valued either by lenders staff or by licenced valuers who prepare written reposts outlining their ‘opinion’ of the properties
- Estimated market value
- Marketability of the property
- Size, type and use of the property
- Location
- Encumbrances
- Planning issues
- Geographic location
- Improvements
- Local economy impact
- Market volatility
- Comparable Sales evidence
And more.
The lender relies heavily on the ‘integrity’ of the valuation report, particularly when a borrower requires a high ‘loan to value’ ratio of borrowings.
In essence, if a borrower only requires a loan representing only 20% of the value of a property (all other things being equal) the likelihood of a ‘bad debt’ loss for the lender is remote.
Of course, if a borrower requires 100% of the value of the property, then the credit risk with the proposed lender (and the mortgage insurer) will increase dramatically. Lenders will then offset this additional risk factor with a comprehensive valuation report, mortgage insurance & often an increased interest rate compared to standard home loan rates.
Conditions
Generally, the ‘conditions’ issue is one that lenders regard when considering the economic circumstances of the overall national economy, the state and regional economies and also the industry type the applicant or security is involved in.
An example of a strong industry type may be ancillary service industries to the WA mining sector. Lenders will look at the macro and micro economic factors relevant to this industry type & will judge the merit of the borrowers application with the added strength (or lack of it) of sound future cash flows, industry growth, employment opportunities & /or demand for a security type.
Clearly, conditions relate to non applicant specific issues.
Character
Character refers to the general impression you make on a prospective lender.
If you have changed jobs 4 times in the last year without a good reason to do so, and you have moved house two or three times as well, have a one or two small credit defaults, and no record of a savings history plus a car loan; your credit profile simply won’t impress the lender overly.
Of course there still may be opportunities to secure mortgage finance, but your options will be limited.
On the other hand, if you have saved some funds or have equity in a property, have no credit defaults, little debt and a sound employment record with residential stability; you will be seen to be a less ‘risky’ borrower.
Of course there is no guarantee that anyone will repay their loan, as per their contract, but assessing the character of a borrower from personal meetings or their preparedness to provided full and frank disclosures, often is a good indicator of future loan conduct.
The five ‘C’s of Credit are issues that all lenders consider in one way or another. Some lenders will process loan applications on a ‘scoring’ basis with limited human interference in the crit approval / decision process.
Lenders have developed robust statistical credit models that isolate poor credit risks based on historical data.
Of course these models are not foolproof, so people still will review marginal cases.
Thankfully, in the recent years, a number of specialist lenders have actually gone back to more ‘traditional’ methods of credit assessment by looking at every application in detail. These specialist lenders are endeavouring to identify reasons to actually approve a loan, when other lenders have scored the loan as ‘declined’.
Lending today has become a vastly more complex industry however to secure the right finance, you really need to secure the right assistance.