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Buying a home can be an exciting, yet stressful time for many Canadians. Thankfully, some advanced planning can make life a lot easier. This includes an understanding of what’s required to get your mortgage approved. In this article, we’ll show you how to qualify for a mortgage, and share some helpful tips so when the time comes, you’ll be ready.
How Can I Qualify For A Mortgage?
Generally speaking, there are 3 components that go into a mortgage approval – credit history, affordability, and equity. While there are other factors to consider, if you can meet the minimum guidelines in the following areas, you’re well on your way be being approved.
Credit History – Your credit report is your track record for repaying your debt. The minimum standard will vary between lenders, but if your credit score falls below a certain threshold (typically below 620), you may not qualify.
Affordability – This refers to the relationship between your gross income (before tax) and the amount of your total debt payments, including your mortgage. The lower the percentage of debt to income, the better your chances. We’ll get into this in more detail a bit later.
Equity – Equity refers to your down payment. At a minimum, you’ll need to be prepared to put down 5% of the purchase price, and an additional 1.5% toward closing costs. A 20% down payment is required for a conventional mortgage.
Insured Vs. Conventional Mortgage
Before you apply, you’ll need to decide if your mortgage will be insured or conventional. The biggest factor here is the amount you’ll be putting toward the down payment. If you plan on putting down less than 20% of the purchase price, your mortgage will need to be insured.
In this case, an insurer such as Canada Mortgage and Housing Corporation (CMHC) will protect the lender against default, should you fail to repay the mortgage. CMHC charges a premium for this, which gets passed on to you, the borrower. In most cases, the insurance premium is included in the mortgage financing.
If your down payment is 20% or higher, the mortgage is considered to be conventional. Because you’re contributing more equity, the chances of default drop significantly, and the mortgage lender doesn’t mind taking on the risk without the backup of CMHC. A conventional mortgage requires a bigger initial investment on the part of the borrower, but borrowing costs are lower and your mortgage payments are smaller. The right path to take is the one that works best for your financial situation.
Acceptable Sources For Your Down Payment
When considering your down payment, you’ll need to make sure that the funds are coming from a source that’s deemed acceptable to your lender, and CMHC (for insured mortgages). In most cases, your down payment cannot come from borrowed funds. You can’t simply take out a loan for $20,000, then turn around the next day and use it as a down payment. Instead, your lender wants to see that you’ve been able to save the funds you’re putting into the home over a period of time. Aside from accumulated savings, a down payment can come from a number of other sources.
Acceptable Down Payment Sources
- Accumulated savings
- Gift from a family member
- Sale of investments
- Funds are withdrawn from an RRSP (Home Buyers Plan)
- Sale of another property
- Equity in your existing home (via a Home Equity Line of Credit)
- Inheritance (will need to provide evidence)
- Settlement from a marital split
Understanding Mortgage Closing Costs
A down payment isn’t the only thing you’ll need to pay for upfront. You’ll be expected to cover closing costs ie. lawyer’s fees, land transfer taxes. This can also include covering a portion of the current year’s property taxes if the seller has already paid them in full. Always budget at least 1.5% of the purchase price to go toward closing costs, over and above your down payment.
How Much Do I Need to Make to Qualify for A Mortgage?
To determine affordability, most lenders will require that your monthly housing costs (mortgage principal, interest and property taxes) not exceed 39% of pre-tax income, and your total debt payments should not be more than 44%. For example, if your monthly income is $5,000, then the total payments on your debt shouldn’t exceed $2,200/month. This includes your mortgage payment, as well as any other obligations, such as a vehicle loan, or minimum payments on credit cards.
Keep in mind that these figures, otherwise known as debt servicing ratios, represent maximum allowable percentages. You need to decide what’s affordable for you. Just because a lender will approve you for a certain amount for a home loan doesn’t mean that you should spend to the limit, as it could have a negative impact on your budget.
What Is Mortgage Pre-Approval?
It’s always a good idea to obtain a mortgage pre-approval before you begin house shopping. A mortgage pre-approval means that a lender has qualified you for a specific mortgage amount based on your credit history, and your income. You’ll also need to demonstrate the ability to come up with the necessary down payment prior to final approval.
The mortgage pre-approval serves a few purposes. Most importantly, it gives you, the borrower, the confidence to shop for a home within a specific price point. It provides your Realtor® with peace of mind, knowing that their client has already been vetted by the lender, and it gives the lender a head start on your mortgage application, which will in turn speed up the process once you’re ready to make an offer on a property.
How Long Does Mortgage Approval Take?
Once you’ve found a home, the length of time it takes for your mortgage to be finalized will depend on the conditions that need to be fulfilled. In most cases, a mortgage application can be turned around within a couple of days, sometimes the same day if your application is solid. From there, you’ll need to make sure any conditions agreed to by the buyer and seller in the Offer to Purchase are fulfilled prior to the possession date.
The Offer To Purchase – Common Conditions
When you enter an agreement to purchase a home, there are a number of conditions that may be requested by both the buyer and seller. Typically, these conditions must be satisfied before the purchase offer is finalized.
- Condition Of Financing: Unless you’re buying a home with cash, you’ll want to place a financing condition in your offer to purchase, to ensure you’ve received mortgage approval from the lender prior to the purchase being finalized.
- Home Inspection: Prospective buyers should always request a home inspection, prior to finalizing their purchase. You never know what problems could be hiding beneath the surface ie. water damage, foundation problems, a leaky roof.
- Home Appraisal: This is often a requirement of the lender, to have an appraiser visit the home to ensure that their security is worth the amount they are lending against it.
- Sale/Purchase Of Another Home. If you have entered an agreement to purchase a home, but you haven’t yet sold your existing home, you can include this as a condition in your offer, to make sure you don’t end up holding more than one mortgage at the same time.
Required Documents For A Mortgage Approval
The following is a list of documents you may need to provide when you enter into an agreement to purchase a home. It’s always a good idea to check with your lender in advance so that you’re fully prepared.
- Offer to Purchase and MLS listing (if available)
- A recent pay stub from your employer
- The past 2 years CRA Notice of Assessments
- A bank statement to confirm ongoing income
- Investment statements to confirm savings balances
- A gift letter if your down payment is being gifted by a family member
- Photo ID
Final Thoughts On Qualifying For A Mortgage
As you can see, Canadians have a lot to consider when looking for a mortgage approval. Our best advice is to do your research well in advance and to make sure you’ve got the 3 big qualifiers in order – credit, affordability, and equity. If so, you’re well on your way to a smoother approval process.
Ready to get pre-approved and find the home of your dreams? Edison Financial is here to help!
Tom Drake is an authority in Canadian personal finance. He is a financial analyst and has been writing about personal finance since 2009 at the award-winning MapleMoney. His work has appeared in MintLife, Canadian MoneySaver, and U.S. News & World Report, and has been quoted in The Globe and Mail, Yahoo Finance, and Financial Post.