Many Canadians might want to start their homebuying journey by contacting a realtor and scoping out open houses, but their first step should actually start in a lender\u2019s office. The mission: To get a mortgage pre-approval. In this process, a potential mortgage lender looks at your finances to figure out the maximum amount they can lend you and what interest rates are available to you.<\/p>\n
Lisa Okun, a Toronto-based mortgage broker, recommends getting a pre-approval right out of the gates. \u201cYou need to understand the financing piece before you start shopping. Through the process of getting a pre-approval letter, you will also get your ducks in a row,\u201d says Okun.<\/p>\n
The key benefits to getting a pre-approval are that you\u2019ll have a ballpark figure for the maximum mortgage you can qualify for and your lender can estimate your monthly mortgage payments. You\u2019ll also be able to lock in an interest rate for up to 120 days. This means if interest rates go up in the months following your pre-approval, most lenders will honour the lower rate that they initially qualified you for.<\/p>\n
That said, pre-approvals have some limitations. Okun breaks it all down here.<\/p>\n
Let\u2019s start with the basics. Where do you get a pre-approval?<\/strong><\/p>\n Mortgages are available from several types of lenders like banks, mortgage companies and credit unions. If you\u2019re getting a traditional mortgage, you can get pre-approved by one of Canada\u2019s major banks or through a mortgage broker or agent. A bank will only be able to offer you mortgage products under their umbrella. Mortgage brokers and agents don\u2019t actually lend the money directly to you. Instead, they arrange the transactions by finding a lender for you and then get a commission from the sale. Unlike a bank, brokers and agents have access to dozens of mortgage products.<\/p>\n Not all mortgage brokers have access to the same products, so it\u2019s important to shop around, do your research, and compare interest rates and products before you settle on \u2018the one\u2019. Even half a percentage point can make a massive difference in the size of your monthly payments and the total interest you\u2019ll pay over the life of your mortgage.<\/p>\n Your pre-approval is not a guarantee.<\/strong><\/p>\n With a pre-approval, your lender is approving you. With a final approval, they will be approving the property you intend to buy, along with ensuring your finances haven\u2019t changed since you were initially given the green light.<\/p>\n \u201cA lender is always going to reserve the right to approve you on a live transaction,\u201d says Okun. \u201cLet\u2019s say someone\u2019s credit score dropped in the six months that they were shopping. That could change things. Now, I may have to assess you at a lower debt servicing ratio.\u201d<\/p>\n In addition to the possibility of your financial snapshot changing, the lender may not like the property you want to buy (remember, as the primary investor, it\u2019s their house too). \u201cIf they believe they would have trouble unloading that property in the event of a default, they may not go for it,\u201d says Okun. \u201cFor condos, many have minimum square footage requirements. If there\u2019s an environmental issue, they may have concerns about that. Or if they decide that you overpaid for it, they might only be willing to finance the property to a certain amount. Then it\u2019s up to the client to decide if they want to come up with the difference, or if they want to walk away from that property.\u201d<\/p>\n What do lenders require for a pre-approval?<\/strong><\/p>\n Whether you go to a bank,mortgage broker or agent, you will need to provide documentation that shows your current assets (whether it\u2019s a car, a cottage, stocks, etc.), your income and employment status, and what percentage of your income will go towards paying your total debts.<\/p>\n Proof of employment<\/strong><\/p>\n Your lender or broker may ask you to provide a current pay stub or letter from your employer stating your title, salary, whether you\u2019re a full-time or part-time employee, and how long you\u2019ve been with the organization.<\/p>\n If you\u2019re self-employed, your lender will need to see your taxes from the last two years (Notices of Assessment from the Canada Revenue Agency). \u201cIdeally, it\u2019s going to show two years of working at the same business,\u201d says Okun. \u201cIf you had one venture and then you abandoned it and you started something new, that\u2019s not going to show as well as if you\u2019ve had the business for three years and your income has steadily increased.\u201d<\/p>\n If you are currently employed, this is not the best time to switch up your resume. \u201cIf someone is full-time employed and they just started in a new job, I can still use a job letter and paystub,\u201d says Okun. \u201cBut ideally, I want it to say they\u2019re not on probation. Not to say that would kill it but it\u2019s a bit easier if they aren\u2019t.\u201d<\/p>\n If you\u2019ve recently switched jobs, your lender may ask to see your tax returns from previous years to confirm that you\u2019ve had continuous employment and have stayed within a relative income bracket.<\/p>\n Proof of downpayment<\/strong><\/p>\n Your lender will want to have an understanding of how liquid your downpayment is. \u201cI usually don\u2019t ask for a history of the funds when we\u2019re discussing pre-approval, but I will ask a lot of questions about where the funds are and how accessible they are,\u201d says Okun. This could include details on whether you\u2019re waiting for an inheritance or gifted funds, selling stocks or other investments, or corralling funds spread across multiple accounts.<\/p>\n Your lender should also have a conversation with you about closing costs, moving costs and ongoing maintenance costs to ensure you\u2019re prepared for the total cost of owning the house you\u2019re approved for.<\/p>\n Credit score<\/strong><\/p>\n Before you meet with a lender to get a pre-approval, order a copy of your credit report and review it for any errors.<\/p>\n If you don\u2019t have a good credit score, the mortgage lender may refuse to approve your mortgage, decide to approve it for a lower amount or at a higher interest rate, only consider your application if you have a large downpayment, or require that someone co-sign with you on the mortgage.<\/p>\n Your credit score will also have an impact on how much mortgage you qualify for. Lenders figure this out by looking at what percentage of your income will go towards your housing costs and total debts (including housing). If your credit score is higher, you are allocated the maximum percentage allowance, which means you get more house for your money. \u201cIf your credit score is above 680, the limit for your gross debt service ratio (GDS) is 39 percent and total debt service ratio (TDS) is 44 percent,\u201d says Okun. More on that below.<\/p>\n Calculating your total monthly housing costs and total debt load.<\/strong><\/p>\n Your gross debt service (GDS) ratio encompasses your monthly mortgage payments, property tax, heating and 50 percent of condo fees (if applicable). This is sometimes referred to as PITH (Principal, Interest, Taxes and Heating).<\/p>\n Your lender will also do a calculation called total debt service ratio (TDS) that determines what percentage of your income is going towards servicing your total debts (including the housing debts you\u2019ll be taking on).<\/p>\n To calculate your TDS, add up PITH and every other debt you have including car loans, credit cards, lines of credit, student loans, etc. Then see how that stacks up against your income.<\/p>\n The guidelines state your GDS should be no more than 32 percent and your TDS should be no more than 40 percent. However, as mentioned above, if you have a fabulous credit score you can stretch this maximum to 39 percent for GDS and 44 percent for TDS.<\/p>\n You might be wondering how your lender can calculate your property taxes when there isn\u2019t a property in question. To do this they set aside one percent of the forecasted purchase price. On a $600,000 property, this amount would work out to $6,000 a year. \u201cIt\u2019s not going to be that much but that\u2019s the calculation your lender will use,\u201d says Okun. That\u2019s why it\u2019s a good idea to run the numbers with your lenders every time you find a property of interest so they reflect your actual affordability.<\/p>\n Levers you can pull if you aren\u2019t pre-approved for the amount you want.<\/strong><\/p>\n Maybe your affordability isn\u2019t reaching as high as you\u2019d like. In this case, there are a few levers you can pull. One option is to go with a \u201cB lender\u201d \u2014 an institution that offers a lower barrier to entry to qualify for their products. The only problem is that this can often be offset with higher interest rates and fees.<\/p>\n \u201cThere are B lenders that would have different debt servicing ratios, and will let us push those numbers a little bit further,\u201d says Okun. \u201cBut you\u2019re going to pay a higher interest rate and there\u2019s going to be a one percent fee to do your deal with them.\u201d Say your mortgage is $800,000. Prepare to be dinged at least $8,000. And it\u2019s not just a one-time fee \u2014 if you have to renew, they\u2019ll ding you again.<\/p>\n \u201cThere\u2019s always a solution, but you have to ask yourself, \u2018Is it worth it and how much is it going to cost?\u2019\u201d says Okun.<\/p>\n Another suggestion Okun shares is to add a cosigner. With an extra income, you\u2019ll have access to a higher purchasing price. \u201cYou\u2019re also going to be taking that person\u2019s liabilities onto the application now, so they have to be a good applicant in terms of their debt,\u201d she says.<\/p>\n You could also contribute more to your downpayment to ensure you\u2019re putting down at least 20 percent. This will give you access to a 30-year amortization, instead of a 25-year (this is the amount of time you\u2019re given to pay your mortgage back in full). \u201cThis stretches your loan over 30 years instead of 25 which changes the payment significantly,\u201d says Okun. \u201cThat allows you to essentially afford more.\u201d Another strategy is to pay off significant debts so they aren\u2019t tipping your debt servicing ratios over the edge.<\/p>\n Where there\u2019s a will (and a patient lender), there is often a way.<\/p>\n