Blog: What is a Mortgage? Understanding the Three C’s of Lending
When you’re buying your first home, you’ll hear the word “mortgage” thrown around constantly. But what exactly is a mortgage, and more importantly, what do banks look for when deciding whether to lend you hundreds of thousands of dollars?
Understanding how mortgages work and what lenders assess is crucial to positioning yourself as an attractive borrower. This knowledge helps you prepare better, avoid surprises, and ultimately secure the best possible loan terms.
What is a Mortgage?
A mortgage is a loan specifically designed for purchasing property. Unlike personal loans or credit cards, mortgages are secured against the property itself. This means if you can’t make your repayments, the lender has the right to sell the property to recover their money (this is called mortgagee sale or foreclosure).
Key features of a mortgage:
Large loan amount: Mortgages are typically the biggest loans you’ll ever take out, often ranging from $300,000 to over $1 million in New Zealand.
Long repayment term: Most mortgages run for 25-30 years, though you can choose shorter or longer terms depending on your circumstances.
Secured by property: The house you’re buying serves as collateral, which is why mortgage interest rates are much lower than unsecured loans.
Interest charges: You pay interest on the amount borrowed. Even a small difference in interest rates can mean tens of thousands of dollars over the life of your loan.
Regular repayments: Most borrowers make fortnightly or monthly repayments that cover both the interest and a portion of the principal (the original amount borrowed).
How Mortgages Work in Practice
Let’s use an example to make this concrete:
You want to buy a house for $700,000. You’ve saved a $140,000 deposit (20%), so you need to borrow $560,000.
The bank agrees to lend you this amount at 6.5% interest over 30 years. Your fortnightly repayment would be approximately $1,800.
In the early years, most of your repayment goes toward interest. As time passes, more goes toward paying down the principal. By the end of 30 years, you’ll own the home outright, having paid back the $560,000 plus approximately $540,000 in interest.
The Three C’s: What Lenders Really Look For
When you apply for a mortgage, lenders don’t just look at whether you have a deposit. They conduct a thorough assessment based on what’s known as the “Three C’s” of lending: Capacity, Character, and Collateral.
Understanding these three factors helps you see your application through the lender’s eyes and improve your chances of approval.
- Capacity: Can You Afford the Repayments?
Capacity refers to your ability to make regular mortgage repayments without financial hardship. This is usually the most important factor lenders consider.
What lenders assess:
Your income: Lenders want to see stable, reliable income. They’ll request:
- Recent payslips (usually last 3 months)
- Employment contracts or letters from your employer
- Tax returns if you’re self-employed (typically 2 years’ worth)
- Proof of any additional income (rental income, investments, bonuses)
Your expenses: Banks don’t just trust what you say about your spending. They’ll review:
- Bank statements (typically 3-6 months)
- Credit card limits (they assume you could max these out)
- Existing loans (car loans, student loans, personal loans)
- Regular commitments (insurance, subscriptions, childcare)
Your debt-to-income ratio (DTI): This measures how much of your income goes toward debt repayments. While New Zealand doesn’t have strict DTI limits like some countries, banks typically prefer your total debt repayments don’t exceed 35-40% of your gross income.
Servicing calculations: Banks test whether you can still afford repayments if interest rates rise. They typically add 2-3% to the current rate to stress-test your affordability. So if you’re applying for a loan at 6.5%, they’ll assess whether you could still manage at 8.5-9.5%.
Ways to improve your capacity:
- Increase your income (ask for a raise, take on a side gig, add a co-borrower)
- Reduce existing debts before applying
- Lower credit card limits (even if you don’t use them)
- Cut discretionary spending and demonstrate good savings habits
- Reduce regular expenses like subscriptions and memberships
- Character: Are You a Reliable Borrower?
Character refers to your credit history and track record with managing money. Lenders want confidence that you’ll make repayments on time and manage credit responsibly.
What lenders assess:
Credit score and history: Your credit report shows:
- Payment history on credit cards, loans, and bills
- Defaults or missed payments
- Court judgments or bankruptcy
- Credit enquiries (how often you’ve applied for credit)
- Credit accounts and their limits
In New Zealand, credit scores typically range from 0-1000. Generally:
- 800+: Excellent (you’ll get best rates and terms)
- 700-799: Very good (most applications approved)
- 600-699: Good (approved with normal rates)
- 500-599: Fair (may need larger deposit or pay higher rates)
- Below 500: Poor (difficult to get approved)
Banking behavior: Lenders review your bank statements looking for:
- Regular income deposits
- Consistent savings patterns
- Responsible spending habits
- Absence of gambling transactions
- No dishonors (bounced payments) or overdraft breaches
- No suspicious or unusual transactions
Employment stability: Frequent job changes can be a red flag. Lenders prefer borrowers with stable employment history. If you’ve recently changed jobs, be prepared to explain why and provide evidence of your ongoing employment.
Existing commitments: How you manage current financial obligations speaks volumes. Regular, on-time payments demonstrate reliability.
Ways to improve your character assessment:
- Check your credit report and dispute any errors
- Pay all bills on time for at least 6 months before applying
- Avoid multiple credit applications in a short period
- Close unused credit cards and accounts
- Clear any defaults or judgments if possible
- Demonstrate regular savings (even small amounts matter)
- Avoid gambling, Buy Now Pay Later schemes, and excessive Uber Eats spending
- Collateral: Is the Property Good Security?
Collateral is the property you’re buying. It serves as security for the loan. If you default, the bank can sell the property to recover their money. Therefore, they need to ensure the property is worth at least what you’re paying for it.
What lenders assess:
Property valuation: The bank will arrange a registered valuation to determine the property’s market value. This can differ from the purchase price. If the valuation comes in lower than your offer, you may need to:
- Renegotiate the purchase price
- Increase your deposit to maintain the required loan-to-value ratio (LVR)
- Provide additional evidence of the property’s value
Property type and condition: Some properties are considered higher risk:
- Leaky buildings or properties with weathertightness issues
- Properties in high-risk zones (flooding, erosion, earthquake)
- Units with pending body corporate issues
- Properties on Māori land or cross-lease titles
- Buildings with certain cladding types
Loan-to-Value Ratio (LVR): This is the percentage of the property’s value you’re borrowing. For example:
- Property value: $700,000
- Loan amount: $560,000
- LVR: 80% (you have a 20% deposit)
Banks have different LVR restrictions. Currently, most require:
- 20% deposit for existing properties
- 10% deposit for new builds
- 5% deposit for first-home buyers using First Home Loan schemes
Location and marketability: Lenders prefer properties in:
- Established areas with good sales history
- Locations with strong demand
- Areas with good infrastructure and amenities
- Markets where properties sell relatively quickly
Ways to strengthen your collateral position:
- Save a larger deposit to reduce LVR
- Consider new builds (often have more favorable LVR requirements)
- Choose properties in established, desirable locations
- Avoid properties with known issues or complications
- Get a pre-purchase building inspection to identify issues early
- Look for properties with broad market appeal
How the Three C’s Work Together
Lenders don’t assess each factor in isolation. They look at your overall profile. Strength in one area can sometimes offset weakness in another.
Examples:
Strong capacity + good character + average collateral: You have excellent income, perfect credit history, but want to buy an older property needing work. The lender may approve but require a larger deposit or building inspection.
Average capacity + excellent character + strong collateral: Your income is modest, but you have impeccable credit and large deposit for a desirable property in great location. The lender will likely approve with favorable terms.
Strong capacity + poor character + strong collateral: You earn great money and have a large deposit, but your credit history shows defaults and missed payments. The lender may decline or charge higher interest rates.
Additional Factors Lenders Consider
Beyond the Three C’s, lenders also look at:
Deposit source: Where did your deposit come from? Banks prefer savings over gifts, though genuine family gifts are generally acceptable if properly documented.
Future plans: Are you planning to start a family, change careers, or take extended leave? These could affect your capacity to repay.
Multiple income streams: Relying on one income is riskier than having two borrowers with stable incomes.
Age and loan term: If you’re older, lenders may be concerned about your ability to repay over a 30-year term.
Preparing for Mortgage Success
Now that you understand what lenders look for, you can take proactive steps to strengthen your application:
6-12 months before applying:
- Check and improve your credit score
- Start demonstrating consistent savings
- Reduce or eliminate unnecessary debts
- Clean up spending habits (less Uber Eats, no gambling)
- Stabilize your employment if possible
3 months before applying:
- Gather required documentation
- Reduce credit card limits
- Avoid new credit applications
- Keep bank statements clean and tidy
- Build up a buffer in your accounts
When applying:
- Be honest and transparent with your lender or adviser
- Provide complete, accurate information
- Respond quickly to any requests for additional documents
- Don’t make major financial changes during the approval process
- Stay in touch with your mortgage adviser
Working with a Mortgage Adviser
Understanding the Three C’s is valuable, but navigating the mortgage market is complex. Different lenders have different appetites for risk and different policies. What one bank declines, another might approve.
This is where a mortgage adviser adds tremendous value. We:
- Assess your position across all Three C’s
- Identify potential issues before you apply
- Match you with lenders most likely to approve your application
- Structure your application to highlight your strengths
- Negotiate on your behalf for better rates and terms
At Innovest, we’ve helped thousands of first-home buyers secure mortgages by understanding exactly what lenders look for and positioning our clients accordingly.
Your Next Steps
Ready to see how you measure up against the Three C’s? Book a free consultation with Innovest today. We’ll:
- Review your financial position
- Identify areas for improvement
- Provide a realistic assessment of your borrowing capacity
- Create an action plan to strengthen your application
- Connect you with the right lenders when you’re ready
Getting a mortgage doesn’t have to be mysterious. With the right knowledge and support, you’ll be holding the keys to your own home sooner than you think.
Disclaimer: This information is general in nature and doesn’t constitute financial advice. Lending criteria and policies vary between lenders and change over time. Speak with a qualified mortgage adviser about your specific situation.
