Things to Consider Before Applying for a Home Loan

Know and understand the five C’s of credit: character, capacity, capital, collateral, and conditions. Lenders use them as a framework to evaluate a borrower’s creditworthiness prior to approval for a financial product and set your loan rate and terms.

Banks and other financial institutions evaluate these factors differently: some create and apply point systems incorporating each element, while others look at the five characteristics more flexibly.
1. Character
To determine the borrower’s character, a lender looks at a mortgage applicant’s overall trustworthiness, personality, and credibility. This aims to determine the responsibility level and likeliness of the applicant to make on-time payments on loans and other debts. Character is evaluated by looking at an applicant’s credit history, past interactions with lenders, and the borrower’s work experience, references, credentials, and overall reputation.
2. Capacity
Capacity summarizes a borrower’s ability to repay a loan based on the applicant’s available cash flow. Lenders consider whether the borrower can cover new loan payments on top of their existing debt service. Relevant factors include the borrower’s income and income stability.

3. Capital
Lenders want to see that you’re committed enough to contribute some of your own funds. For major purchases, such as a home or property, lenders look at the down payment size the borrower is committing to the purchase.
4. Conditions
Any external factors that might impact loan repayment, such as the economy’s overall health and specifics of the loan, including the loan interest rate, amount of principal, and intended use of the loan proceeds.
5. Collateral
A borrower’s ability—and willingness—to pledge valuable collateral reduces the risk to the lender.
These are the most common types of collateral that lenders accept:
• Real estate
• Cars
• Cash or checking and savings account balances
• Certificates of deposit and other investments

Understanding the five C’s of credit is necessary before applying for a loan. Personal loan prequalification can help you evaluate whether you’re likely to qualify, but understanding the five C’s can provide a deeper understanding of whether the approval is likely or not.

Each one is important in the loan process. You may need to spend time improving one or more elements. Here’s how to improve your overall financial situation and bolster your creditworthiness before applying for a loan.

• Increase your savings. Increasing your savings improves how your assets look on paper and illustrates that you can repay a loan. Depending on your savings goals, this strategy can also increase how much capital you have for a down payment.
• Make consistent, on-time bill payments. Payment history accounts for 35% of a consumer’s credit score, the largest of any other category. On-time monthly payments can improve your credit score over time and demonstrate your good character to lenders.
• Pay off debts early. The amount a borrower owes makes up 30% of their credit score. Making extra payments or paying off debts early can improve your credit score. This also improves your capacity to repay the loan, thereby reducing the risk you pose to a lender.
• Wait to open other new accounts or credit cards. Borrowers who open multiple credit accounts in a short period of time are considered riskier than borrowers who do not. While it only accounts for 10% of a credit score calculation, any new credit you take out can speak to your character and your capacity to cover debt.
• Request a credit limit increase. A credit utilization rate is the ratio of how much a borrower owes on revolving lines of credit to the overall credit limit. To improve your ratio, consider requesting a credit limit increase.
• Lower Your Debt-to-Income Ratio. Lenders look at your debt-to-income ratio to measure your ability to manage the payments you make each month and to determine how much house you can afford. If you have a low debt-to-income ratio, it shows you have a good balance between debt and income.

Qualifying for a loan and fulfilling your dream of owning a home is much more likely with a few simple financial improvements.