The Four C’s relating to Borrowing
A well-made table has four solid legs and a well-made borrower is aware of the four C’s of borrowing: character, capacity, collateral and credit. These are the four legs you bring to the table for borrowing. What does each of these legs mean and how does each one keep your table level and sturdy?
Character -
Character is your work and income history. Every borrower needs to show the ability to repay the loan. Have you been regularly employed for at least three years? Financial Institutions will want to see that you have a regular income so you will be in a position to make your loan repayments. If you are a job hopper or your income is sporadic because your line of work is seasonal, you may be viewed as a risk. While child support and alimony may be viewed as income, it must be verified and continued for at least three years. If you are self-employed and own your business, banks usually want to calculate the average of your monthly net income over three years. (two years audited financials plus management accounts to date). Payments of income such as commissions, bonuses and overtime also need to be averaged over two years. By averaging everything over those 24 months, banks will obtain a better gauge of your ability to repay that loan.
Capacity -
Capacity is what you can afford. Are you already leveraged to the hilt? The rule of thumb is that your housing costs (bond, taxes, insurance and general household expenses) should be no more than 38 percent of your monthly income. However, after adding in the rest of what you owe, your total ratio of debt to income (DTI) should be no more than 43 percent of your monthly income. If your DTI ratio is higher, your debt load is too heavy and the banks may be concerned that you will not be in a position to carry that weight, however, they may make exceptions depending on the overall scenario.
Collateral -
Collateral is your home. Your home is what the lender utilizes to make sure that if you do not pay back the monies loaned to you, there is an asset there to help the lender get the money back. This is done through a process called foreclosure, in which you give the home back to the lender in exchange for the balance you owe on the home (not a good idea and will negatively affect your credit moving forward). That is the reason most lenders require a deposit. In some instances, if no deposit is paid the bank may require bond insurance. This insurance protects the lender and not the borrower. Banks want you to have enough funds to cover all the transfer and legal costs, usually, if the bank covers those costs, it will be in exchange for a higher interest rate.
Credit -
Credit is your payment history and is undoubtedly the most important C. Banks know that if you regularly pay your debts in the past, you most likely will continue to pay your debts. To establish credit, you should have at least two years of debt payments and a few accounts reporting your credit. How is your credit scored (analyzed)? The higher your score, the better your credit is, and the easier it is to get a loan and a favourable interest rate. Did you make any late payments in the past two years? Do you have any judgment, liens, bankruptcies or loan modifications? Any of those negative actions will bring down your credit score. The lower your credit score, the less likely you will qualify.