How lenders judge borrowers

Lenders typically use four criteria when deciding whether to approve your loan. They are known as the four "Cs."

• Capacity
• Credit
• Collateral
• Character

Capacity

Capacity helps lenders measure your ability to repay a loan. It's determined by weighing your housing expenses and total debt against your monthly income.

• Monthly income. This is your total monthly gross income. If you're self-employed or receive commissions or bonuses, the lender averages your total monthly gross income over the last two years.
• Housing expenses. This is the monthly payment you'll have with the new loan, along with the monthly cost of insurance, property taxes and any homeowner's fees or other costs.
• Total debt. Add up any current mortgages, credit card balances, child support or alimony payments, tuition, car loans or other installment loans that will take longer than 10 months to pay off and this is your total debt.

If your monthly mortgage payment is less than 28% of your gross monthly income, a lender will typically consider you qualified to repay the loan. That figure can even go as high as 36% depending on the borrower. For instance, many lenders will allow a first-time buyer's housing expenses to take up more of their income.

Credit

Your credit history is another measure lenders use in deciding whether to make a loan. Lenders evaluate your credit risk by examining your:

• Previous mortgage payment history
• Rent payment history
• Credit card use
• Installment debt payment history

A few late payments on a credit card may not hurt you all that much, but collections, repossessions, foreclosures and bankruptcies can be serious problems.

Collateral

When you request a home loan, you're putting the home itself up as collateral. Naturally, the lender will want to know that the home is worth at least as much as the loan amount, which is why an appraisal is required.

But they'll also want proof that you have the cash necessary for the down payment and closing costs. They'll seek verification of funds from sources including bank accounts, stocks, bonds, mutual funds, the sale of an existing property and any gift funds from family members that will not have to be repaid.

Character

The way you conduct your financial transactions tells a lender a great deal about your fiscal character. If you take responsibility for your debts by paying your bills regularly and on time, you will appear to have the integrity they're looking for in a borrower.

Other factors

Many factors figure into a lender's decision to approve a loan. Generally, lenders want to be confident when making a loan that you will pay it back. A few or only minor problems with your credit shouldn't discourage you from applying.

Build a good credit history

Whether you're applying for a home loan, auto loan or credit card, lenders want assurance that you'll be able to pay back the loan. Your credit history helps them decide that. It shows that you've had loans in the past and paid them back. Building and maintaining a good credit history improve your chances of getting the loan approved.

Here are some ways to begin building and maintaining a good credit history:

• Open a checking and savings account.
• Open a retail charge account.
• Apply for a bank credit card.
• Apply for a secured credit card account.
• Take out a small installment loan.
• Buy something on credit at a major store.
• Apply for a gasoline credit card.
• Always pay your bills on time.

Start small to get use to budgeting for monthly payments on a loan or credit card. A small, short-term installment loan or credit card will keep your monthly payments low so you can fit them into your budget.

What you should know about credit reports

Credit reports document your financial behavior over the past seven years - how much credit you have, how long you've had it and whether you pay your bills on time, among other things. Knowing what information is in your report can help you identify any problem areas and plan what steps you might take to correct them.

Three credit reporting agencies - Equifax, TransUnion and Experian - maintain credit reports. Lenders buy credit reports to help them decide whether to approve your loan. Your credit report contains information about:

• Credit accounts and payment history
• Applications you have made for loans and other time payments
• Personal information, including your name address and Social Security number
• Employment information
• Legal actions (for example, judgments, collections, bankruptcy)

Your credit report also carries your credit score, a numeric ranking between 300 and 850 that many lenders use to decide whether you are creditworthy. The score is used to help predict whether you'll repay a loan. It's calculated using five sources:

• Payment history
• Amount owed
• Length of credit history
• New credit
• Types of credit in use

In addition to telling lenders your creditworthiness, your credit score can also influence the interest rate you pay. In many cases the higher your score, the lower your interest rate.

Why should I buy, instead of rent?

You'll love the feeling of having something that's all yours - a home where your own personal style will tell the world who you are. A thriving vegetable garden in the backyard, a tiled entryway, a yellow kitchen...when you own, you can do it all your way! But there's more to owning a home than personal satisfaction. You can deduct the cost of your mortgage loan interest from your federal income taxes, and usually from your state taxes, too. And interest will compose nearly all of your monthly payment , for over half the number of years you'll be paying your mortgage. This adds up to hefty savings at the end of each year. And you're also allowed to deduct the property taxes you pay as a homeowner. If you rent, you write your monthly check and it's gone forever. Another financial plus in owning a home is the possibility its value will go up through the years.

Should I use a real estate broker? How do I find one?

Using a real estate broker is a very good idea. All the details involved in home buying, particularly the financial ones, can be mind-boggling. A good real estate professional can guide you through the entire process and make the experience much easier. A real estate broker will be well-acquainted with all the important things you'll want to know about a neighborhood you may be considering...the quality of schools, the number of children in the area, the safety of the neighborhood, traffic volume, and more. He or she will help you figure the price range you can afford and search the classified ads and multiple listing services for homes you'll want to see. With immediate access to homes as soon as they're put on the market, the broker can save you hours of wasted driving-around time. When it's time to make an offer on a home, the broker can point out ways to structure your deal to save you money. He or she will explain the advantages and disadvantages of different types of mortgages, guide you through the paperwork, and be there to hold your hand and answer last-minute questions when you sign the final papers at closing. And you don't have to pay the broker anything! The payment comes from the home seller - not from the buyer.

Extra Repayments

There are lots of ways to save money on your mortgage, but the golden rule is to pay as much as you can afford to each month. Every dollar you pay over your normal monthly repayments goes towards lowering the principal amount you owe the lender, and shortens the term of your loan and therefore your overall interest cost. If you want to save interest costs by paying your mortgage off quickly, make sure your loan allows you to do it. Most fixed term and rate loans and some basic loans don't allow you to make additional repayments, or charge a penalty for doing so. Make sure you understand the terms and conditions before taking out your loan.