What Are Lenders Looking For? Capacity!

When a lender is confronted with a borrower seeking financing they are looking for the 4 Cs of borrowing. In a post entitled “What is the Greatest Obstacle to Borrowing Money to Purchase a House?” I explained what the 4 Cs of borrowing are. In this post I intend to get much more specific as to what the lender is looking for in each of the 4 Cs: 1) Character, 2) Capacity, 3) Collateral, and 4) Credit.

debt-to-income-ratioWhen considering a borrower’s Capacity, lenders are looking primarily at the borrower’s income from employment and investments and whether a borrower can afford to repay the debt. To determine whether a borrower can afford to pay the debt the lender will calculate the percentage of income that will be obligated to the total monthly mortgage payment as well as the percentage of income that will be obligated to the total monthly mortgage and debt payments.

The total monthly mortgage payment includes principal & interest, mortgage insurance (if applicable), property taxes, Mello-Roos, homeowners insurance, HOA dues (if applicable). This is typically referred to as a front (or top) ratio, and should generally not exceed 36% of a borrower’s gross monthly income.

Monthly debt payments include all debts listed on a borrower’s credit report and are comprised of installment loans and revolving accounts. Typical installment loan accounts include autos, RVs, toy haulers, ATVs, quads, watercraft, furniture, etc… Typical revolving credit accounts include major credit and charge cards such as Visa®, Mastercard®, American Express®, and Discover®, and also include department store and specialty store accounts such as Nordstrom, JCPenney, Macy’s, Victoria’s Secret, etc… However, lenders do not stop there. They also consider other monthly payments, such as student loans, whether in deferment or not, 401(k) loans, Union dues, spousal support, and child support. This is typically referred to as a back (or bottom) ratio, and should generally not exceed 43% of a borrower’s gross monthly income.

House projectWhile a lender doesn’t take into consideration the cost of expenses such as trash collection, yard maintenance, water, gas, electric, cable, internet, and phone, it is important for anybody contemplating purchasing a home to factor these into their decision because they are real costs and will affect your experience of homeownership. You may be paying these items already and may see little or no increase in the cost of these items. However, your situation may be one where you aren’t currently paying any of these items and you don’t want to be blind-sided by these inevitable costs.

As a homeowner, you will be financially responsible for upkeep and general maintenance, such as the garbage disposal, faucets, water heater, roof, rain gutters, fences, landscaping, etc… and you may wish to consider the impact of these things on your overall cost of ownership. While these items may not show up as recurring monthly expenses, they will affect your monthly budget as they typically fall in the category of life’s little unbudgeted emergencies. You’ll find that some can be put off and some cannot be put off.

If you’re interested in learning more about what it takes to purchase a home of your own, you’ll want to read other posts in the series, such as So, You Want to Buy a House?, The Power of Pre-Approval vs Prequalification, What is the Greatest Obstacle to Borrowing Money to Purchase a House?, What Are Lenders Looking For? Character!, What Are Lenders Looking For? Capacity!What Are Lenders Looking For? Collateral!What Are Lenders Looking For? Credit!The Two Approvals, and more.

If you’re interested in learning more about what to consider before paying cash for any major capital purchase, download our FREE report entitled “Is Paying Cash Detrimental to Your Financial Health?” We also encourage you to contact us to schedule a time to talk about your specific circumstances.

Leave a Comment