How Your Loan Applications Are Evaluated

When you apply for a loan, lenders evaluate your application to assess the risk involved in the loan, which is called the “underwriting” process. The bigger the loan, the more extensive the underwriting process should be. In general, they make loan decisions based on the documentation you provided, your credit report, and your credit score.

Credit report: Your lender will order your credit report to see your credit worthiness. Your credit report contains a factual record of your credit payment history. It shows how you treat credit and your relationships with creditors.
Credit Score: Along with the credit report, lenders can also buy a credit score based on the information in the report. Credit scoring uses statistical models to assess an individual's credit worthiness based on their credit history and current credit accounts. Most creditors now use credit scoring because it allows for speedy, objective analysis of credit histories.
Documentation you provide: Your lender will ask you to provide documents that show your employment, income, assets and liabilities, such as your W-2 form, tax return, mortgage statement, bank statements, purchase contract, and etc.

What will they be looking for?

During this underwriting process, lenders try to predict whether you'll repay your debts on time by looking at your capacity, character, and collateral/capital, known as the "three C's".

Capacity: Can you afford to pay back this loan?
Capacity is the ability to repay a debt. The lender checks your income and outstanding financial obligations before loan is approved. He wants to know where you work, for how long, and how much you earn. Your living expenses, open credit limits, current debts and other payments give the lender a sense of how much debt you can realistically pay given your income.
Character: Are you willing to pay back this loan?
Your attitude toward your credit obligations is often seen as the most important factor in predicting whether you will make regular payments and repay the loan on time. Your length of residency and employment help lenders develop a feeling of your personal stability. More importantly, lenders evaluate your financial character by reviewing your credit history. They check your credit report to see whether or not you have made your payments on time and will continue to do so.
Collateral: If you don't pay back the loan, from what asset can the lender recover their principal?
Collateral is any possession you have that could be used to secure the loan. Collateral is measured by the size of your down-payment in the event of a purchase, or the amount of equity you have in your property in the event of a refinance. In general, the larger the down-payment or the greater the equity you have the more attractive the rates and terms you will be offered.

Lenders use different combinations of the above facts to reach their decision. So even if you come up a little short in one area, perhaps one of your stronger points will make up for the weak one. What is more important to note is that there are all different loan programs available with different set of guidelines for analyzing the 3 C's. Some lenders set unusually high standards, and some simply do not make certain kinds of loans. However, there are also loan programs designed for self-employed individuals or loans for borrowers with credit problems.

Regardless of all different situations, you can greatly improve the chance of getting a more favorable loan by understanding how lenders access your credit risk and reshaping your financial life to meet the lender’s guidelines early on.

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