Article by Huffingtonpost
If you’re planning to buy a home, you’ll probably need to get a mortgage. Comparing mortgage rates is a good first step, but applying and getting approved for a mortgage is the most important part of the process. While it may seem difficult and daunting, with the right preparation, getting a mortgage approval can be a relatively smooth process.
1. Check (and improve) your credit score
Your credit score is a number between 300 and 900 that indicates your overall credit-worthiness. Whenever you make a late payment, apply for credit, or default on a loan, credit reporting agencies will note it on your credit history and lower your credit score. A higher score shows that you’ve been committed to making loan repayments in the past and are therefore less likely to default. This indicates to mortgage lenders that you’re more likely to pay back your loan on time and makes them more willing to lend you money.
Here are the typical ranges for credit scores in Canada:
- Below 599: Poor credit
- 600 to 679: Fair credit
- Above 680: Very good credit
If you have poor credit, mortgage lenders will assume that you’re less likely to make repayments on time, which makes lending to you riskier. Most major banks won’t take that risk and thus, won’t approve you for a mortgage if your credit score is under 600. Instead, you may need to use a “B lender” or even a private lender, which will charge you a higher mortgage rate to compensate for the extra risk.
In order to have access to better mortgage lenders and lower rates, you should try to improve your credit score before you apply for a mortgage. Here are a few steps you can take:
- Check your credit score, so you can measure your progress. There are online tools that will let you do this for free.
- Pay your bills on time and in full, especially for credit cards and loans.
- Try to use less than 30% of your overall credit limit.
- Don’t apply for more credit than you need. Lots of applications for credit can hurt your credit score.
- Keep your oldest credit card active, even if you don’t use it. Having a long credit history is good for your credit score.
2. Pay down your existing debt
Lenders will look at your debt-to-income ratio when deciding whether to lend to you. They’ll want to know that your income can cover your mortgage payments, even after paying off your existing debt. That means existing debt can impact how much you’re able to borrow.
The first part of this ratio is your income, which you’ll want to keep as high and as stable as possible. Being in a full-time job for a long time is ideal. Aside from increasing your income, paying off your existing debt is the best way to maximize your mortgage affordability. This includes car loans, student loans, credit cards, and any other credit line with regular payments. By paying as much of your debt off as you can, you’ll have a higher income-to-debt ratio when you apply for a mortgage.
More detail on debt ratios: Your mortgage provider will use two different kinds of debt ratios to determine how much you can afford to borrow, your Gross Debt Service Ratio (GDS) and your Total Debt Service Ratio (TDS). The general guideline from the Canada Mortgage and Housing Corporation (CMHC) is to have a GDS of less than 35 per cent and a TDS of less than 42 per cent. Your GDS is the percentage of your monthly income that pays for your housing costs under your new mortgage. Your TDS is similar to your GDS in that it factors in your housing costs, but it also includes your other debts such as car payments and credit card loans.
The takeaway is that with a higher income and lower existing debt you’ll be able to apply for a larger mortgage. If you can’t easily increase your income, then paying off as much of your existing debt as possible will help improve your debt service ratio.
3. Save more for a larger down payment
In Canada, the minimum down payment required is determined by your home’s purchase price.
- For homes with a purchase price of $500,000 or less, the minimum down payment is five per cent
- For homes with a purchase price between $500,001 and $999,999, the minimum down payment is five per cent of the first $500,000 of the purchase price plus 10 per cent of the remaining portion
- For homes with a purchase price of $1,000,000 or more, the minimum down payment is 20 per cent
Of course, you always have the option to put in a down payment that is above the minimum requirement. This has a few key benefits:
- A larger down payment increases your maximum affordability. Because of the minimum down payment rules, increasing the size of your down payment also increases the maximum purchase price you can afford.
- Increasing your down payment while maintaining the same home buying budget means you’ll need to borrow less and take out a small mortgage. A smaller mortgage attracts less interest over time, saving you money. Your monthly mortgage payments will also be lower, which will make budgeting easier.
- A down payment of at least 20 per cent saves you the cost of mortgage default insurance, which is mandatory for mortgages with down payments of less than 20 per cent. This can result in savings of several thousands of dollars.
4. Know what you can afford
Before you start house hunting, it’s important to have a realistic budget, so that you can contain your search to homes that you can actually afford. This will allow you to save time and avoid disappointment.
Once you’ve set aside as much as you can for your down payment and minimized your existing debt, you have everything you need to calculate how much you can afford. When you do, make sure you consider all the additional expenses associated with a home purchase, also known as closing costs. A few closing costs you may not immediately think about are:
- Legal fees
- Home inspection and appraisal costs
- Land transfer taxes
- Title insurance
- Provincial Sales Tax (PST) on mortgage insurance (if your down payment is under 20 per cent)
Using Ratehub’s mortgage affordability calculator is the easiest way to understand how much you can truly afford, as it will not only show you the maximum home price you can afford, it will also show you how much additional cash you’ll need for the home purchase.
5. Get a mortgage pre-approval
Once your financials are in order and you’re ready to start your house hunt, the first thing you should do is get a mortgage pre-approval. A mortgage pre-approval shows the mortgage amount a lender is willing to loan you and the mortgage rate they’re willing to hold for you. It gives you certainty on what you can afford, thereby allowing you to move quickly when making an offer on a house you like. Although a pre-approval does not guarantee that your actual mortgage application will be approved, if your financial situation and employment remain unchanged between the time you get your pre-approval and apply for your actual mortgage, then getting approved should not be too difficult.
There are some key benefits to getting a pre-approval:
- It forces you to get your application together early, so you’re prepared when you actually apply for your mortgage.
- Most lenders will hold your pre-approved mortgage rate for 90 to 120 days. This protects you from rate increases within that time frame, allowing you to shop for a home without having to worry about rates increasing. If rates go down by the time you purchase a home, the lender will usually offer you the lower rate.
- A pre-approval lets you know what your actual home buying budget is, and is a way to prove that you’re a serious buyer when you’re ready to make an offer.
- There’s no obligation to get your actual mortgage with the lender you got your pre-approval from. Once you make an offer to purchase a home, it’s a good idea to shop for the best mortgage rates at that time so you can get the best deal.
- Getting a mortgage pre-approval is free.
The bottom line
Getting approved for a mortgage may feel overwhelming if it’s your first time, but it doesn’t have to be too stressful if you’re well prepared. If you get ready in the ways we’ve outlined, including getting a mortgage pre-approval, getting approved should be fairly straightforward.
For personalized advice and information on the mortgage process, it’s best to consult with a mortgage professional such as a mortgage broker. Mortgage brokers can give you expert, personalized advice, and don’t charge a consultation fee.
Article by Huffingtonpost.ca