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The 4 C’s of Mortgage Underwriting

With Spring upon us, and new buyers out looking for houses, I thought today might be a good time to review the basics of what lenders look for as they decide to approve (or deny) mortgage applications. For at least 25 years, I have heard them called “The 4 C’s of Underwriting”- Capacity, Credit, Cash, and Collateral.  Guidelines and risk tolerances change, but the core criteria do not.


CAPACITY is the analysis of comparing a borrower’s income to their proposed debt. It considers the borrower’s ability to repay the mortgage. Lenders look at two calculations (we call ratios). The first is your Housing Ratio. It simply is the percentage of your proposed total mortgage payment (principal & interest, real estate taxes, homeowner’s insurance and, if applicable, flood insurance and mortgage insurance – like PMI or the FHA MIP) divided by your monthly, pre-tax income. A solid Housing Ratio (often called the front end ratio) would be 28% or less; although, many times loans are approved at a significantly higher number. That’s because your front end ratio is looked at in conjunction with your back end ratio.

The back end ratio (referred to as your Debt Ratio) starts with that mortgage payment calculation from the Housing Ratio and adds to it your recurring debts that would show up on your credit report (auto loans, student loans, minimum credit card payments, etc.) without taking into consideration some other debts (phone bills, utility bills, cable TV). A good back ratio would be 40% or less. However, many loans are granted with higher debt ratios. Understand that every application is different. Income can be impacted by overtime, night differential, bonuses, job history, unreimbursed expenses, commission, as well as other factors. Similarly, how your debts are considered can vary. Consult an experienced loan officer to determine how the underwriter will calculate your numbers.


CREDIT is the statistical prediction of a borrower’s future payment likelihood. By reviewing the past factors (payment history, total debt compared to total available debt, the types of monies: revolving credit vs. installment debt outstanding) a credit score is assigned each borrower which reflects the anticipated repayment. The higher your score, the lower the risk to the lender which usually results in better loan terms for the borrower. Scores below 620 are difficult (though not impossible); scores from 620-660 are mediocre; those from 660-720 are considered good; and above 720 are very good. Your loan officer will look to run your credit early on to see what challenges may (or may not) present themselves.


CASH is a review of your asset picture after you close. There are really two components – cash in the deal and cash in reserves. Simply put, the bigger your down payment (the more of your own money at risk) the stronger the loan application. At the same time, the more money you have in reserve after closing the less likely you are to default. Two borrowers with the same profile as far as income ratios and credit scores have different risk levels if one has $50,000 in the bank after closing and the other has $50. There is logic here. The source of your assets will be examined. Is it savings? Was it a gift? Was it a one-time settlement/lottery victory/bonus? Discuss how much money you have and its origins with your loan officer.


COLLATERAL refers to the appraisal of your home. It considers many factors – sales of comparable homes, location of the home, size of the home, condition of the home, cost to rebuild the home, and even rental income options. Understand the lender does not want to foreclose (they aren’t in the real estate business), but they do need to have something to secure the loan against, in case of default. In today’s market, appraisers tend to be conservative in their evaluations. Appraisals are really the only one of the 4 C’s that can’t be determined ahead of time in most cases.

Now, each of the 4 C’s are important, but it’s really the combination of them that is key. Strong income ratios and a large down payment with strong reserves can offset some credit issues. Similarly, long and strong credit histories help higher ratios….and good credit and income can overcome lesser down payments. Talk openly and freely with your loan officer. They are on your side, advocating for you and looking to structure your file as favorably as possible.

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5 replies
  1. David Mott
    David Mott says:

    “cost to rebuild the home”

    It’s good to see this mentioned. One insurance agent here in Oregon mentions $130 a square foot rebuilding costs. Another mentions $145 a square foot, even up to $170.

    It’s in the appraiser’s arsenal to use the ‘cost to build’ approach to establish value, yet most seem to use depressed sales information.

    We had an appraiser use the local sales info in the MLS to find ‘comps’ for our property. He used $50 a square foot to make square foot adjustments. No one can get anything built for $50 a square foot here. Had he used the cost to build approach, the property would probably be unsellable as the price would be too high for most buyers. This appraiser even used a foreclosure in the comps. If you pick 5 comps, and one of them is a foreclosure, then you are saying that 20% of the market is made up of foreclosures.

    When houses are selling for less than the cost to build, and the underwriters are taking their sweet time to process loans, it tells me that maybe the demand for low interest bearing paper is just not there. For this reason, I don’t think we’ll see the real estate market rebound until the mortgage rates start to climb above 6%.


    Its now Sept, rates have dropped to 60 years lows but lenders arent offering the lowest rates because they already have too much paperwork in the pipe to handle.
    30-day rate locks are often unrealistically short.

    Big deal, according to some estimates 1/3 to 1/2 of applications cant get thru the underwriting process so the deal falls thru.

    Its sadly ironic that 5-7 years ago the banks so badly wanted to get into the RE business they lobbied hard and now they’re stuck with the mess they help create.


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  1. […] does a great job in explaining what each C means http://kcmblog.com/2011/05/05/the-4-cs-of-mortgage-underwriting « Tips For Meeting Down Payment Requirements LikeBe the first to like this […]

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