Getting A Mortgage: The Four C’s of Credit

For first-time home buyers, the mortgage process can be daunting. It is often confusing what mortgage lenders are looking for and how they determine your approval limits. So today, I am happy to have Cindi Conley, a 30-year veteran of the industry, here to break it down for you. She’s going to share the four key components of the mortgage process to help you navigate the home buying process like a pro. Take it away, Cindi!

Applying for a mortgage is a complex and mysterious process for both first-time home buyers and repeat borrowers. And to a lender, a loan applicant is someone they don’t know, asking for a lot of money to purchase a property the lender’s never seen. They decide if they’re ok via a method they’ve been using for decades. Yes, it involves mathematical equations, but don’t focus on the math. Focus on the technique behind the Four C’s of Credit.

The Four C’s are a framework underwriters (the person making the lending decision) use to build a story about you from all the documents you provide when you apply. While everyone’s finances are unique, the Four C’s are applied in the same way to every file. Underwriters use the Four C’s to decide if you can afford the mortgage today and predict (or guess) if you’ll be able to afford it for as long as you have the mortgage.

The Four C’s

Start with a general overview of the Four C’s:

  • Capacity: This tells the story about your ability (capacity) to make the mortgage payment. Income documents are collected to see how you earn money, how long you’ve earned it in this way, and where you earn it. It also includes details about your debt – how much you have, if it’s increased or decreased, and the monthly cost.
  • Credit: The underwriter reviews your credit report which includes details about credit cards (open and closed), installment loans and mortgages. It also has balance and payment histories, current balances, minimum monthly payments and the actual payment amount you make.
  • Capital: This is all about your cash. Underwriters will look at where all your money came from – earnings, savings, or gift? They will also confirm that you have enough for the down payment, closing costs, and your first mortgage payment.  
  • Collateral: The review of the value and condition of the property. An independent appraiser assesses the property and its condition, including information on the neighborhood in the report.

Capacity – Can You Make the Payments?

Since an underwriter can’t sit down and interview you personally, each of the Four C’s relies on documentation to communicate your story. The documents are your ‘voice.’ To understand this concept, let’s take a deep dive into each one, beginning with Capacity.

For underwriters to determine if you can repay a mortgage, it’s not as simple as documenting your income and monthly payments. They consider what you do for a living and how long you’ve been doing it by gathering income documents for the past two years.

If you’re employed, the last two years W-2 forms will be required, and the current full month of pay stubs. Everything that happened within the last two years – job changes, change of industry, or unemployment – can be found in the documents you provide. Pay stubs contain current earnings, year-to-date earnings, how often you’re paid, and bonus or commissions income if you earn them.

If you do earn a commission or bonus, referred to as variable income, the underwriter will take what the bonus/commissions you’ve received over the two years and divide by 24 months to calculate the average.  

Be prepared to explain any gaps or changes with a brief letter, and supporting documentation. Your “story” is told via your documents in your loan file which is passed on to others for review both during and after the loan process.

Proving Capacity When Self-Employed

If you’re self-employed, you’ll provide the last two years’ tax returns (personal and business), a Profit and Loss statement, and a Balance sheet for the current year. Depending on the legal structure of your business there may be other documents you’ll need to provide so the underwriter can calculate your qualifying income.

Credit – What You’ve Borrowed

While Capacity includes a review of your debt, it blends into the next C: Credit. The central document in this C is your credit report which is used to evaluate if you’re creditworthy. The report documents many details besides your credit, including date of birth, social security number, public records, and, of course, your credit scores.

The three credit bureaus (Equifax, Experian, and TransUnion) have added more details to credit reports over the last few years. They now include spending and payment history for several years, which gives the underwriter a full picture of how you use credit. For example, you may have a credit card that had a high balance for a few months but has a zero balance now. The underwriter will see this and want to know the source of the money used to pay off the balance and will ask for any documentation that gives the details.

Underwriters will also use your credit report to calculate the debt-to-income (DTI) ratio or the percentage of your monthly income needed to pay your debt. They take the minimum monthly payments from the report, add them to the proposed mortgage payment and divide the total by your monthly income. The maximum allowed is between 43-45% of your income (before taxes), depending on the size of the mortgage.

Considering Credit Scores

Yes, they do look at your credit scores. Credit scoring started when Fair Isaac developed a computer model to predict the likelihood of a consumer being 90 days late on a credit obligation sometime in the future. Soon after, all three credit bureaus (Equifax, TransUnion, and Experian) developed similar scoring models, and ‘credit scores’ became a permanent part of mortgage underwriting.

A credit review doesn’t stop with your score and DTI percentage. Underwriters look for late payments and whether you make minimum payments monthly or pay large chunks. They look for large spikes in credit card balances, maxed out credit cards, or whether you use credit at all. Why are these important?

Well, if you carry high balances and make minimum payments, that tells the underwriter you’re at your maximum debt payment capacity based on your income. Or if you don’t use credit much, or at all, there’s no way for the underwriter to predict if you’ll pay back a large debt like a mortgage.

Capital – Your Money

The next C, Capital, is one of the most critical as underwriters confirm that you have the cash you’ll need for the down payment and closing costs, referred to as ‘cash to close.’ You’ll need to provide two months of complete statements for any asset accounts containing your cash-to-close including checking, savings, retirement, and investment accounts.

The underwriter uses your statements to confirm where your money is held and how long you’ve been accumulating (saving) it. The ability to save is an essential part of the underwriting decision. Borrowers who aren’t living paycheck to paycheck but are prepared for an unexpected financial issue are a good credit risk for lenders. Note that a history of repaying student loans is proof of your ‘ability to save’.

You may receive requests for additional documentation regarding your assets because underwriters must comply with the Anti-Money Laundering and Patriot Acts. In general, this means the source of incoming funds to your accounts must be identified, either directly on your statements or by separate documents. If you have large deposits or large payments listed on your statements, you’ll be asked for a written explanation and any documents to support it.

Collateral – The Value of Your Future Home

The final C, Collateral, is all about the property and what it’s worth. Lenders need an independent assessment of the property in case you stop making the payments one day and they have to sell the property to pay off the loan. So, before deciding to make the loan, they appraise the property to make sure it’s worth enough to cover the mortgage in that worse case scenario.

The appraisal details the specific characteristics of a property and compares it to sales of similar properties nearby. The appraised value is based on comparable recent sales and the condition of those properties when they sold. The appraised value is adjusted based on your potential property’s condition compared to other recent sales. For example, if a neighboring property underwent a luxury renovation before its sale, the value of your property will be adjusted down in comparison.

It’s important to note that an appraisal is for the benefit of the lender, as described above, and not to confirm that you’re paying a reasonable price. Also, if the appraiser sees visible signs of disrepair that could present a ‘health and safety’ issue, they’ll note this on the report. These can include issues with plumbing, electrical, or heating systems and they must be repaired before the loan can close.

Taking Control of the 4 C’s

While there is a basic checklist of documents every borrower must provide when applying for a mortgage, that may not give the underwriter your complete story. Now that you know what each of the Four C’s focuses on uncovering, you can apply it to your unique financial situation. When the underwriter asks you for more details, in writing, remember that they’re just trying to learn your story – and document it in the loan file.

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Cindi Conley is a freelance business writer specializing in personal finance. A mortgage and real estate subject matter expert after a 30+ year career in Mortgage Banking, she ghostwrites for mortgage companies, financial service businesses, and real estate agents – all while living life in Northern California. You can find her at, or on Twitter @Cindithewriter.

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2 thoughts on “Getting A Mortgage: The Four C’s of Credit”

  1. I appreciate your article as my son will most likely buy a house in 15 months and I am considering a small vacation home. My question is regarding the capacity and crdit mix of 43 – 48 % of income – is that net or gross income?

  2. Hi Ann,
    the debt to income ratios is based on your income before taxes. That’s an easier calculation if you’re employed and receive a paycheck and W-2 versus self-employed.
    Also, in your case, when you buy a vacation home, your full monthly payment on your primary home is part of your total monthly debt. If you’re planning on renting out the vacation home at all, the projected income won’t be considered when calculating your ratio.

    Hope this helps Ann!

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