The “Three C’s” listed here are the key criteria that determine how much you qualify to borrow and the rate and terms of your loan.
• Your credit history, or FICO score
• Your Capacity to Repay, or Debt-to-Income ratio (DTI)
• Your home’s Collateral value, or Loan-to-Loan ratio (LTV)
Most lenders use a FICO rating from a “tri-merge FICO report” to check your credit.
This report, prepared by the Fair Isaac Corporation (FICO) gathers and collates information collected by the “big three” credit reporting agencies in the U.S., Experian, Equifax and TransUnion.
FICO combines information about your credit history and standing into a summary report, and calculates your “aggregated” credit score or FICO rating, a number between 300 and 850.
As a rule of thumb, higher FICO scores result in lower interest rates and more favorable terms. With some exceptions, the best rates and terms go to borrowers with the best (740 or higher) credit scores.
Among other things, lenders consider your capability to afford the payments associated with your loan when determining if you qualify for the loan. One way to do this is to evaluate your overall indebtedness compared to your total income to arrive at your Debt-To-Income ratio (DTI).
For example, if your monthly debt payments total $2,000 and your income (your annual income before taxes or other deductions, divided by 12) totals $6,000, your DTI would be 2,000 divided by 6,000, or .33. In other words, one-third of your income currently goes to debt payments.
DTI indicates whether you have the capability to take on an additional debt payment. A high DTI may indicate that you already pay too much to service the current debt and taking on a new loan would be risky for you and your lender.
Collateral is the value of your home relative to the amount you’re borrowing. Collateral is expressed as a Loan-to-Value ratio (LTV).
For example, if your loan value is $175,000, and your home (or the home you intend to purchase) appraises at $250,000, the LTV would be 70%...
Like DTI, LTV indicates something about the level of risk to you and your lender if you take out a loan. Lower LTV reduces the risk. A high LTV (above 80%) may indicate an unacceptable level of risk. This could mean you may be required to mitigate the risk through Private Mortgage Insurance (PMI).