Chapter 3: The Four C's of Underwriting
Overview
Underwriting is the critical decision-making stage in the
mortgage lifecycle where a lender assesses the risk of lending to a borrower.
This assessment is structured around the Four C’s of Underwriting: Credit,
Capacity, Capital, and Collateral. Each "C" represents a core
component that lenders evaluate to determine the borrower’s ability and
willingness to repay the loan.
1. Credit
What It Is:
Credit represents the borrower’s history of repaying debts.
Key Documents:
- Credit
Report (Tri-Merged: Experian, Equifax, TransUnion)
- Credit
Scores (FICO/Beacon)
Evaluation Focus:
- Payment
history
- Credit
utilization ratio
- Length
of credit history
- Recent
inquiries
- Types
of credit accounts
Red Flags:
- Late
payments (30/60/90 days)
- Collections
or charge-offs
- Bankruptcy,
foreclosure
- Recent
inquiries without new accounts
2. Capacity
What It Is:
Capacity refers to the borrower’s income and ability to
repay the mortgage loan.
Key Documents:
- Pay
Stubs (30 days)
- W-2
Forms (2 years)
- Tax
Returns (1040s, Schedule C for self-employed)
- VOE
(Verification of Employment)
- P&L
statements for businesses
- Rental
income documentation
Evaluation Focus:
- Monthly
gross income
- Debt-to-Income
Ratio (DTI)
- Job
stability and income consistency
DTI Calculation:
Front-End DTI = (Housing Expenses / Gross Monthly Income) x
100
Back-End DTI = (Total Monthly Debts / Gross Monthly Income)
x 100
Red Flags:
- Unverifiable
income
- High
DTI (> 43% typically)
- Frequent
job changes
- Large
income drops YoY
3. Capital
What It Is:
Capital refers to the borrower’s assets that can be used for
down payment, reserves, and closing costs.
Key Documents:
- Bank
Statements (60 days)
- Gift
Letters
- VOD
(Verification of Deposit)
- Retirement
and Investment Account Statements
Evaluation Focus:
- Sufficient
assets for:
- Down
payment
- Closing
costs
- Reserves
(typically 2–6 months of PITIA)
- Asset
seasoning and sourcing
Red Flags:
- Large,
unexplained deposits
- Bounced
checks
- Unacceptable
gift documentation
- Non-liquid
assets presented as liquid
4. Collateral
What It Is:
Collateral is the property being financed and serves as
security for the loan.
Key Documents:
- Appraisal
Report (URAR 1004)
- Purchase
Agreement
- Title
Commitment
- Homeowners
Insurance Binder
Evaluation Focus:
- Loan-to-Value
Ratio (LTV)
- Property
condition and marketability
- Title
search for liens, encumbrances
LTV Calculation:
LTV = (Loan Amount / Appraised Value or Purchase Price) x
100
Red Flags:
- Low
appraisal value
- Property
not habitable
- Title
issues
- Insurance
coverage gaps
Summary Table of 4 C’s
|
C |
Focus Area |
Key Metrics & Docs |
Common Issues |
|
Credit |
Creditworthiness |
FICO, Payment history, Tradelines |
Late pays, collections |
|
Capacity |
Income & DTI |
Pay stubs, Tax returns, DTI |
High DTI, unstable employment |
|
Capital |
Assets & Down Payment |
Bank statements, Reserves |
Unsourced deposits, low reserves |
|
Collateral |
Property as Security |
Appraisal, Title, Insurance |
Low value, defects, liens |
Final Notes
- A
deficiency in one "C" may be offset by strength in another
(compensating factors).
- Mortgage
guidelines vary (FHA, VA, Conventional) — thresholds for each C differ.
- A
strong understanding of the Four C’s allows underwriters to make accurate,
risk-aware decisions.
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