The four main elements which play a significant role in deciding the amount and interest rate of the mortgage pre-approval are discussed below.
1. Credit score.
Your credit score indicates your fiscal well-being, thus revealing to lenders the potential danger of offering you a loan. A credit score between 680 to 900 is usually sufficient to be eligible for an “A” level lender such as a major bank.
If your credit score is between 600 to 680, lenders would take into account your other financial details to determine if you can be approved for an “A” level lender or not. In case you don’t meet the criteria, you may need to acquire pre-approval from a “B” level lender, such as Home Trust.
For those whose credit score is lower than 600, a mortgage can be acquired only from a “B” level lender and unfortunately you will not receive today’s best mortgage rates.
2. Down payment.
The down payment you provide is the sum of money that will be put towards the purchase of your home. According to the regulations in Canada, the minimal down payment must be somewhere between 5% to 20% of the price of the house. When making a down payment of less than 20%, mortgage default insurance (which is also known as CMHC insurance or from other mortgage default insurance providers) needs to be bought to safeguard the lender from any possible defaults in the loan payment.
The size of your down payment determines the maximum amount that you can borrow. For instance, for a house of worth $300,000, at least $15,000 is needed for the down payment.
$300,000 x 5% = $15,000.
Minimum down payments in Canada:
For houses valued at less than $500,000, the least down payment required is 5%. In the case of a house between $500,000 to $1 million, 5% of the initial $500,000 needs to be put down, then 10% of the amount exceeding $500,000. An example of this is, a house worth $600,000 will require a minimum down payment of $35,000.
($500,000 x 5% = $25,000) + ($100,000 x 10% = $10,000) = $35,000.
In the case of a house priced over $1 million, the minimal down payment is 20%.
3. Debt service ratios.
Your debt service ratios consist of two calculations used by lenders to ascertain the largest mortgage payment that you can afford based on your monthly income, expenses and debts.
Lenders rely on these ratios to make sure you are capable of making the monthly mortgage payments, along with all your other monetary commitments, thus reducing the risk of defaults on mortgage payments.
4. Supporting documentation.
The required documentation to receive pre-approval from a mortgage broker or lender may vary. While some brokers may need proof of income for pre-approval, others may ask for it only after your offer has been accepted and you are required to complete your mortgage application.
The list of documentation that may be necessary for mortgage pre-approval include:
- Identification (e.g. Canadian driver’s license, PR card or passport)
- Proof of income (pay stubs and letter from your employer, or a notice of assessment if you are self-employed)
- Length of time with employer.
- Proof of down payment and ability to pay closing costs (recent financial statements of bank accounts and investments)
- Proof of any other assets like a car, cottage or boat.
- Information about other debts including: credit cards or lines of credit; spousal or child support payments; student loans; car leases or loans; and personal loans.
After obtaining mortgage pre-approval, you will be informed of the maximum amount that you are able to borrow, along with the mortgage rate that lenders are prepared to offer. This pre-approval offers you protection from any interest rate hikes in the upcoming 90 to 120 days while you search for the right home. You can utilize the maximum mortgage amount to determine what you are capable of affording and thus only look at homes that are within your financial capabilities.
It is necessary to keep in mind that having pre-approval does not necessarily mean that your ultimate mortgage application will be approved. Once you have had your Offer to Purchase accepted, the lender will review the property’s specifics to make sure it meets their qualifications. In cases such as the home containing asbestos, knob and tube wiring, being a heritage property, or its appraised value is below the purchase price, the lender may not be content with the home and can deny you the mortgage.
It is also critical to remember that just because you have pre-approval does not mean you should buy a house that is the top of your budget range. Your pre-approval amount is an indication of what the lender is willing to lend you, not necessarily the most you should spend. Therefore, it is best to select a house that is below the maximum price you are able to pay, to leave enough in your budget for savings and debt repayment.
If you require any assistance, it is highly recommended to consult with a mortgage broker who can provide you with professional advice, at no cost. They are able to help you compare mortgages and negotiate a more favourable rate, as well as walk you through the pre-approval process.