When determining the INVESTMENT QUALITY of a loan, lenders assign the loan with the equivalent of a grade - 'A' paper being the highest quality loan, and 'D' paper being the highest risk to the investor.

To help determine if a loan is an A paper or not, the federal National Mortgage Association (Fannie Mae) and the federal Home Loan Mortgage Corporation (Freddie Mac) have established guidelines to determine the investment quality of the loan. These guidelines help lenders to make their decisions and also enable the investors that buy the securities that are backed by these mortgages to know how much risk they are taking.

An investment quality loan can be defined as a loan made to a borrower from which timely repayment can be expected and that the loan is secured by sufficient collateral in case of default. A lender uses the guidelines provided by Fannie Mae and Freddie Mac to determine if a loan is of investment quality.

If the loan falls outside the guidelines, it can be considered a B, C, or D paper loan, depending upon how far outside the established guidelines a particular loan falls. A lender who is making a B, C or D paper loan is taking a higher risk since there is an increased likelihood of the loan defaulting. The lender is compensated for higher risk by charging the borrower a higher interest rate.

It is important to remember that the loan decision process can be subjective and the guidelines are just that, guidelines, not rules etched in stone. Therefore, different lenders may rate the same loan differently when determining the investment quality of a loan. That is where your mortgage broker comes in as he or she knows which lender can give the highest grade to your loan.

Also, some lenders use credit scoring system to determine the credit risk. There are three main credit scoring systems - Equifax's Beacon, TRW's FICO and Transunion's Empirica - that predict the likelihood that an existing account or potential credit customer will become a serious credit risk. Beacon has a minimum credit score of 400 with a maximum of 844. FICO score ranges from mid 400's to high 800's. Empirica is similar to both FICO and Beacon. The higher the credit score, the better the credit risk. Generally speaking, a credit score of 680 or so should put one in 'A' paper category.

It must however be noted that not all lenders give same value to a particular credit score. Besides, not all lenders use credit scoring system and even when they do they may not use credit scoring system for all their loan programs. Once again, your mortgage broker is your best guide as he or she should know right away as to which lender will not only accept your credit score but will also be able to offer you the best rate in your situation.

Two main factors determine your Credit Grade:

1. Credit

2. Debt Ratio

'A' Paper: In plain english, A Paper refers to borrowers with excellent credit which means no late charges whatsoever for last 7 years. Debt ratios of no more than 28/38. As usual, marginal exceptions are possible with strong compensating factors.

'B' Paper allows borrower up to three 30 day mortgage late charges, up to two 60 day and one 90 day instalment or revolving accounts late charges during the last 24 months. Back end debt ratio to be no more than 48%. Any Bankruptcy dismissal or discharge should be over 3 years ago with reestablished credit. These are general guidelines and may vary from lender to lender. Exceptions are always possible with strong compensating factors. Besides 'A' and 'B', the mortgage industry also have 'A'-, 'B'+, 'C' and 'D' paper, too. 'D' papers refers to what is known as hard money loans which are mostly based on the equity in your home and not on your credit. Back end ratio could be as high as 65% but Loan to Value ratio drops to less than 65%..

Loan-to-Value Ratio (LTV) refers to the loan amount as percentage of the market value of the house. A $100,000 loan on a $200,000 house will be at 50% LTV. The higher the LTV, the stringent the lenders become on credit and income. Under 65% LTV, most any loan can fly even if one has major Credit and Debt Ratio problems. As of the writing of this program, if one is an 'A' paper, one can get 100% LTV loan and in some cases even 125%.

Debt Ratio (DR) stands for income-to-debt ratio. Traditionally, the debt ratio has been somewhat like 33/36. 33 is called the front ratio and 36 the back ratio. They are also known as top and bottom ratios. The 33% refers to your monthly housing expense (PITI) as a percentage of your gross monthly income and 36% represents your PITI plus total of your all other recurring monthly payments on personal loans, credit cards, auto loans etc. However, lately these ratios have been stretched. FHA accepts as much as 29/41. Conventional 'A' paper loans are being done at as much as 36/42 and even more. 'D' papers loans, of-course, go up to 60% back ratio.
 

Besides, Credit and Debt Ratio, other factors are your discretionary income, job stability and the most important your real property also has to qualify.