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The Four C’s of 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 up?

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 two years? Banks wants to see that you have a regular income so you can make your loan payments. 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 can be viewed as income, it must be verified and continued for at least three years. If you’re self-employed and own your business, banks want to calculate the average of your monthly net income over two years. 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 can get 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 (mortgage, taxes, insurance and HOA) should be no more than 38 percent of your monthly income. But 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 fear you can’t carry that weight, but may make exceptions depending on the overall scenario.

Collateral

Collateral is the house. It is what the lender uses to make sure that if you don’t pay back the money loaned to you, there is something 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). That is the reason most lenders require money down and if you do not put 20 percent down your lender will likely require mortgage insurance. This insurance protects the lender and not the borrower. Banks want you to have enough for a down payment and closing costs. If the bank covers those costs, it usually 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 paid 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 four 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 favorable 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.

Tips & Advice 5 Financial Advantages of Owning a Home

Your home is your castle, but there are also many financial advantages of owning a home. Here are five ways that owning can be better than renting.

1. As a Hedge Against Inflation

Your rent will go up on a regular basis, while your payment on a 30-year fixed mortgage will always remain the same.

Let’s say your monthly rent is $1,800. Assuming inflation (your rent increase) is 3 percent, in five years your monthly rent will be $2,026. By then, you will have paid about $115,000 of your landlord’s mortgage.

2. To Build Your Personal Wealth

Stop paying your landlord’s mortgage. When you own your home, your mortgage amount is going down and your property value is going up.

No other investment, asset or debt is as misunderstood as a home. A home can be a wonderful and lucrative investment, but like any investment, it needs to be regularly reviewed, maintained and, when appropriate, sold. Even if your home is paid off, you still pay costs for repairs and upkeep, taxes and insurance. But like any investment, if you own it long term, take care of it and sell when the market is right, you stand to make a great gain.

3. Tax Savings (Federal and State)

Under Section 163 of the IRS code, interest on loans used to acquire, construct or improve real estate is deductible on up to a $1,000,000 mortgage.

Interest on loans tied to real estate for any reason is deductible on up to a $100,000 mortgage. For example, interest on the first $100,000 of a home equity line of credit (HELOC) is tax deductible.

Let’s say you make $100,000 per year and rent a home for $1,800 per month. You would have to pay taxes on your entire income of $100,000 when you are renting that home. If you purchase a home with a monthly payment of $1,800, you only have to pay taxes on $78,400 of your annual income because the interest you paid on your mortgage can be used as a tax deduction.

4. Asset Diversification

Unlike with a 401(k) or IRA, when you invest in a home you can live in it while the investment grows.

Owning a home over an extended period of time is usually more lucrative than renting. With good planning and execution, you can learn to minimize the cost of homeownership and maximize the ability to create real wealth. Many small business owners have a home office and can use the home office as a tax deduction while they are earning income. Other homeowners will rent out a bedroom and use the rent to pay down their mortgage and gain equity faster.

5. Forced Savings

Monthly mortgage payments lower your mortgage, essentially creating a forced savings account.

In five years with a $1,800 monthly mortgage payment, you will have paid $29,331 of the principal on your mortgage. That would be money in your pocket if you choose to sell. For this example we use a $345,000 mortgage loan amount at a 4.75 percent interest rate, 4.881 percent APR and use a standard amortization table to come up with the principal pay down.

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