In this week's episode, we are discussing the 4 Cs of credit and how they impact your ability to get a mortgage. https://www.balancedfi.com/4-cs-of-credit/ The 4 Cs are: capacity, capital, collateral, and credit score. This episode will give you tips for improving each C when you apply for that mortgage… but you could also use this knowledge to improve your finances overall.
Welcome to the Balanced FI Podcast, episode 33 - The 4 Cs of Credit: What You Need to Know
Although you probably haven’t heard of them, the 4 Cs of credit are:
Improving one or all of these areas can greatly improve your odds of being approved for a mortgage or getting a better interest rate.
FIND US:
Balancedfi.com -- Podcast -- Facebook -- Instagram -- Pinterest -- Hello@balancedfi.com
RESOURCES:
Read: The 4 Cs of Credit: What You Need to Know
Read: Do You Need a Credit Score While Debt-Free?
Resource: Loan Savings Calculator
Resource: National Foundation for Credit Counseling
SOURCES:
Source: What’s in my FICO Scores?
Source: What Is a Credit Score, and What Are the Credit Score Ranges?
Source: How Credit Score Affects Your Mortgage Rate
📍 📍 Hey there, this is episode 33 of the balanced five podcast, the four C's of credit. What you need to know. Welcome to the balance five podcast, where we talk about balancing intentional debt payoff, saving money, and actually living your life. I'm your host, Raylia. Small business owner, wife, girl mom, non profit co founder, and money nerd.
This is an audio version of the Balanced Five blog, because I know how hard it is to find time to sit down and read literally anything. Instead, you can get quick bits of money knowledge on the go. I want to help you learn to control your money instead of letting your money control you. Let's get started.
Hi, and welcome back to the podcast. Before we get started, I have a little bit of housekeeping to go over. I'm still planning to put out one podcast episode every week for the foreseeable future, but I'm going to be cutting back on my writing efforts. It's just to give me more time to focus on finally creating the content for Intentionally Debt Free.
Intentionally Debt Free is the online course that I have been kicking around in my mind for months now, and I'm ready to finally get it out there into the world. It will help you go from feeling overwhelmed by your finances, to and hopeless To having control and having a plan for finally getting out of debt Even if you don't have debt this course can help you create a spending plan Get a handle on your finances and just understand your financial situation so much better Plus, I am super excited about this course It's this amazing Excel spreadsheet that I have created to go along with the course.
And it will help you finally like really see the numbers and how your choices impact your future. Watch for that. And if you are a reader of my blog, don't worry about the decrease in content. Just know that there's something awesome coming down the road. Now, let's get started on credit. Although you may have never even heard of them, the forces of credit have a big impact on your ability to get a mortgage and other loans.
But mortgages are usually the biggest concern. It's not always fair, but your financial past does play a big part in your financial future. So what are the four C's of credit? Capacity to pay the loan back. Capital, collateral, and credit score. Why are the four C's of credit important? The four C's of credit are the criteria that an underwriter looks at when deciding whether or not to approve a loan application.
So the underwriter is the person at the bank or mortgage company who evaluates loans and makes the decision on whether to grant the loan or not. What is capacity? In this instance, capacity measures your ability to pay the loan back. The mortgage processor will look at your income, your employment history, the amount you have saved in the bank, and how much you already pay each month toward other debts.
And those all affect your capacity. What is capital? Capital is the amount of available cash you have. This would include the money in the bank, investment accounts, other property owned, and other things that can be sold for cash relatively easily. The mortgage holder looks at your capital as a measure of your ability to pay back the loan.
What is collateral? Collateral is the asset that you use to secure the loan. That means that if you stop paying the loan, the bank or the loan holder can take the asset, foreclose it, on it, and sell it to get their money back. For a mortgage, the collateral is almost always the property being purchased.
And when a house is foreclosed upon, the bank is seizing the collateral of the mortgage in order to make some of their money back. For the lender, collateral is probably the most important of the four C's of credit. If the collateral isn't worth as much as the loan, you're probably not getting that loan.
A new mortgage or a refinance usually requires an appraisal of the property to make sure that it's still valuable enough to justify the new loan you're requesting. What is credit? Your credit score is a measure of how you have handled debt in the past. A credit score takes into consideration on time payments, how much you owe overall, how long you've had your credit accounts, what types of credit you have, and if you have had new credit accounts or credit inquiries in the recent past.
Credit scores can range from 300 to 850. A higher credit score makes you look better to lenders, so they're more willing to offer you lower interest rates on loans. People who are debt free may still need a credit score for many reasons, though. Renting a home, applying for certain jobs, and more are impacted by your credit score.
So it really is an important number. What is a good credit score? So there are three credit reporting bureaus, Experian, Equifax, and TransUnion. Each independently reports your score, so there may be slight differences between the bureaus. Generalizations of score ranges, though, are 720 to 850 is excellent.
690 to 719 is good, 630 to 689 is fair, and 350 to 629 is poor credit. How does credit affect your mortgage rate? So a higher credit score signals to the mortgage company that you are historically more responsible with your money and you're more likely to pay off this new loan. Of course, it's not a perfect system and more education about the subject is really needed for most people.
Improving your credit score by 100 points can literally save you thousands of dollars in interest over the term of your mortgage. When planning to purchase a home, improving your credit score could be worth the effort. So there's a website that I'll link to in the show notes. It's called MyFICO. FICO is one of the credit score formulas.
And it has a nice loan savings calculator. I ran some numbers through it and the results are pretty crazy. So there's a table on the blog post that goes with this episode and you can actually look at the numbers. But improving your credit score from 695 to 705, so it's just 10 points difference, would save you 10, 000 in interest over this hypothetical loan term that I put into the calculator.
So that is a huge difference, and it's not so super hard to improve your credit score. It just takes time. What if I have a low credit score? According to NerdWallet, you may be able to qualify for the following types of loans with a less than great credit score. FHA loans require a credit score of at least 500.
VA loans require a credit score of 620. And USDA loans usually require at least a 640 score. So you would have to qualify for the loan's other requirements, but know that there are options if your score isn't the best. This episode is brought to you by the Money Makeover Challenge. This is the newest free money challenge from Balanced Fi.
Each month, you can download a calendar with one money saving step each day. They're little things that can turn into habits to make over your money long term. Even if you don't implement every tip, just focusing on your spending will slowly start to make over your money mindset. You can't make big changes until you're aware that there's a problem.
The Money Makeover Challenge is the best way to trigger that change. Free. Convenient. Easy. Go to balancedfi. com slash money makeover challenge to download your calendar today.
How can you improve your chances of getting a mortgage? In short, improving the four C's of credit will help you get a mortgage or a better interest rate. Let's start with capacity. The most obvious way to increase your capacity or ability to pay back your mortgage is to increase your income. Having more money per month makes you more attractive to the bank.
You could also decrease the amount of the mortgage you're seeking approval for. A smaller mortgage creates smaller monthly payments, so your existing income would cover more. Capital. Improve your capital ranking by saving more before seeking a mortgage. If you have the time, save at least a 20 percent down payment.
This will decrease the amount you need to borrow and help your mortgage application look more attractive. Of course, I know it's not always possible or practical to wait until you have saved a 20 percent down payment. Maybe your housing needs are more critical. Maybe you're moving to an area with limited rentals.
Maybe you have another good reason. Just know that having a larger down payment does help. Collateral. When seeking a mortgage, it's important to ensure that the property appraises for as much or more than the mortgage amount. You'll almost never get approved for a mortgage for more than the appraised value of the property.
In a hot real estate market, like so many areas have right now, it may be difficult to move quickly enough and get a large enough mortgage when homes are selling above asking price. Unfortunately, having large reserves of cash is the best way to buy a home in a crazy market like that. Credit score. The best way to increase your credit score is to pay off debt, which will decrease your credit utilization, and that's the percentage of available credit that you're actively using.
Using less than 30 percent of your available credit is good, but 0 percent is even better. It's also important to continue to make existing payments on time and not take out any additional debt when you're planning for a new mortgage. Something people often ask is, are credit counseling services legit?
Credit counseling services are groups that help you improve your credit score. Some credit counseling services are genuinely helpful agencies and some are scams. You have to be careful when working with a service so that you don't actually make your situation worse. Start with the National Foundation for Credit Counseling.
There's a link in the show notes. It's a non profit that employs credit counselors and will help you for free. This is the most reputable way to get help when you're improving your credit score. To avoid being drawn into a scam, never pay for credit counseling services. There are sketchy companies that purport to improve credit scores, but they won't actually do so or they'll just take your money.
So to recap, the four C's of credit are capacity to pay the loan back, capital, collateral, and credit score. You can improve your chances of getting approved for a mortgage or other loans by improving the four C's. And what should you do next? If you're looking to get a mortgage in the near future, look at each of the 4 C's in your own life.
Which area can you improve? I do have other resources for easy ways to improve your credit score, so that might be something you want to check out. It's on my blog, you can just search for credit score. And that is it for today. Thanks for listening and I will talk to you next week. Thank you for listening to this episode.
If you enjoy the Balanced Fi podcast, I'd be so grateful if you left us a review on iTunes or told a friend. As always, you can head to balancedfi. com to connect with me and stay in touch. I'm on Facebook, Instagram, Pinterest, and Twitter at Balanced Fi. Until next time, stay intentional and look for balance.