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Capacity

Simply put, capacity refers to the borrower’s ability to make the payments on the loan. To determine this, mortgage bankers analyze the borrower’s employment and income, their debt and their assets.

Stability of the income is the most important element of determining capacity. People who are employed for big companies and receive regular wages are the least risky, while self-employed borrowers pose the greatest risk from the lender’s point of view, because they are responsible for the success of their business, in addition to their personal responsibilities.

Another important aspect when evaluating capacity is the so-called debt to income ratio. The debt to income ratio is calculated by adding up all of the monthly liabilities and obligations (mortgage payments, other credit payments, child support, alimony etc.) and dividing it by the monthly income of the borrower. The ratio must be below anywhere from 32% for the most conservative loans to 65% for the most aggressive loans.

Assets are also considered in the capacity evaluation. Having a lot of liquid assets is a positive sign for the lender, because that means that the borrower has reserves to pay his monthly mortgage obligations. The most typical asset is the borrowers checking and savings account. Other assets are the retirement funds (401k, Individual Retirement Account), investments (stock, mutual funds, CDs) and any other liquid funds.