How Does Bad Credit and Low Income Affect Getting a Second Mortgage

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How Does Bad Credit and Low Income Affect Getting a Mortgage or Refinancing?

The terms of any loan, whether it's a few dollars from a friend, or a $500,000 mortgage from a financial institution, are usually dictated by three C's: credit, capacity, and collateral.

Credit: The terms credit score and FICO score are usually interchangeable terms, and are numeric scores that measure a borrowers good faith willingness to pay back financial obligations on time, and in full. Banks will ascertain your FICO score by running your credit report, which is a snapshot of your borrowing and payment history, and will help the bank decide whether or not you are a financial risk to lend money to.

Capacity: A borrower may have demonstrated good faith willingness to repay debts in the past, but do they have the means to pay back a new loan now? Capacity measures whether or not borrowers have means to pay back money they borrow. Lending institutions can attempt to gauge this by reviewing a loan applicants current job, their monthly income, previous job history, and the likelihood that the applicant's current income will continue for the foreseeable future.

Collateral: Refers to security pledged for repayment of a loan. In the case of a mortgage, the house that a loan is secured against serves as collateral for the bank. When approving home loans, banks must compare how much they are lending to the actual market value of the house. This is usually expressed as a percentage called Loan to Value (LTV) which is simply, the loan amount divided by the value of the collateral. For example, a lender may consider it a strong loan, with lower financial risk, if they are lending $100,000 against a home that's worth $200,000 (50% LTV). The lender has plenty of room to recover their loss should they have to liquidate the collateral. The higher the LTV, the higher the risk for the bank's money, the higher the interest rate they will charge a borrower to compensate for this risk.

Lending money is basically a gamble on the lender's behalf, regardless of to whom they lend it. The less of a risk a borrower is, the less the lender has to worry about what happens if the borrower doesn't pay, and the more likely the lender will be to lend money at the lowest rates. This risk is calculated by trustworthiness (credit) and ability to pay (income).

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