Would you loan you money?
Lending money is risky business. Just put yourself behind the lender’s desk for a minute, and you’ll see what I mean. Many times the lender does not see the person to whom they are lending money. If you were the banker, would you loan someone like you $200,000 sight unseen with no questions asked? Not hardly. What questions would you ask a borrower before signing such a big check?
Where do you work? How much do you earn? How long have you worked there? How much do you owe? How big a down payment will you make? Where is the down payment money coming from? All are appropriate questions to ask would-be borrowers.
As a lender you want assurance that your loan will be repaid in full and on time. To help them decide, lenders rely on the four C’s of lending: character, capacity, capital and collateral.
Character explores whether or not you pay your bills and if you pay them on time. Lenders want to know about bankruptcies, foreclosures and whether or not you have been slow to pay.
Capacity looks as how much you earn in relation to how much you spend. Lenders won’t be impressed with a $100,000-a-year income if they see you already spending that amount or more.
When lenders inquire about your capital, they are asking about your investments, such as other real estate holdings, savings, stocks, certificates of deposit, 401Ks and IRAs. If you have a complete collection of Beanie Babies, they want to know that, too. Sources of capital vary from person to person.
Lastly, lenders want to know about your collateral. After all, they may end up owning it.
Lending is an evolving process. Old habits and old perspectives are changing. Lenders have actually become more lenient because the perception of risk has changed. If someone meets the criteria for a Fannie Mae loan, local lenders are more likely to approve the loan because they know they will be able to sell it in the secondary market.
Finances are more global today. Money for loans comes from around the world. It’s not just your local savings and loan putting up the money any more.
What makes lending a risky business? Many things. A bad economy is one. A buyer who easily qualified for a loan could run up additional debt and have difficulty repaying the loan.
Market interest rates might change. If you are a lender, and rates go down, that’s good for you. You are receiving interest that’s higher than the prevailing rate. If rates go up, you may wish you had loaned money to someone else.
Thirty years is a long time to loan someone money. Now there’s talk of a 40-year home loan. If an 80-year-old couple qualifies for a 30-year loan, who is more optimistic, the applicants or the lender? After all, lenders cannot discriminate for reasons of age. A qualified borrower is a qualified borrower.
Changing portfolios cause lenders to lose sleep as well. Last year a borrower heavily invested in technology stocks might have been seen as a good risk. Today that same borrower will face many more questions about his or her investment choices.
Of course, borrowers face risk too. It’s easy to get into financial difficulty. Just look at all the credit card solicitations you receive weekly. A 30-year loan commitment means you will be making payments for a big part of your life. And then there are lifestyle changes. Children arrive, get married, leave home, and come back.
When borrowers sit down to sign a loan, they are doing so based on their best guess about what likely is to happen to them in the future. The lender is doing the same.
Contributed by David S. Jones, reprinted with permission from the Real Estate Center at Texas A&M University.