Chapter 1 Research and Pre-Qualify

 Determining Mortgage Affordability

 

There are numerous factors that lenders look at when determining how much of a mortgage you can afford. Here, we outline four key factors lenders look at when evaluating your loan application.

• Credit Score

Think of your credit score as a grade in high school. The higher your grade, the more likely you are to get into competitive universities and colleges. The same principle applies to financing: the higher your credit score, the more likely a lender will approve your loan. This is because higher credit scores are seen as less risky to the lender. Your credit score considers a variety of factors, such as:

• • Payment History – this reflects the number of your payments, the frequency of your payments, whether your payments are timely, whether you have missed any payments, etc. 
  • Credit Utilization – this is the amount of credit you have used expressed as a percentage of the credit you have available to you. Lower credit utilization ratios are more favourable to your credit score. Credit utilization ratios below 30% are considered ideal. To calculate your credit utilization: 
    • Credit utilization = (sum of credit used/sum of credit available) x 100%
  • Length of Credit History – the longer your history of making timely payments, paying back loans, and keeping lower credit utilization ratios, the higher your credit score is likely to be. 

Other factors impact your credit score, albeit to a lesser extent, such as the number of recent inquiries from lenders you have. When you apply for credit, lenders pull your credit report. This is called an inquiry. There are two types of inquiries – soft and hard. A soft inquiry does not impact your credit score, while a hard inquiry does. More hard inquiries signal to potential lenders that you may have money management issues or that you are being declined for loans, and thus generally have negative impacts on your credit score. 

• Income

As with any credit application, your income is an important factor a lender considers when approving a mortgage application. Lenders generally consider all sources of income, including salary, dividend and interest income, rental income, etc. 

 

Generally, lenders tend to approve mortgage loan applications where less than 30% of a person’s monthly income is spent on home expenses (mortgage payment, property taxes, insurance, etc.)

• Current Loans

Existing loans, such as car loans and student debt, could impact your eligibility for a mortgage. Lenders will look at whether your existing debt could impact your ability to pay your mortgage payments. 

• Down Payment Percentage

Generally, lenders are more favourable to purchasers who are prepared to make larger down payments on properties. 

 

Generally, 20% is considered an ideal down payment. This is not to say that you cannot qualify for a mortgage with less than 20%, but in most cases, lenders want to see that you have significant equity in the property.

 

Specific information for financing in Canada

 

The minimum down payment in Canada is 5%. Please note, down payments between 5% and 19.99%, require CMHC default insurance.

 

Additionally, the legislation mandates that homes over $1 million require a minimum 20% down payment to qualify for financing. These homes are ineligible for CMHC insurance.

 

Also, there are two key metrics that many lenders place considerable emphasis on when determining loan approvals: your Gross Debt Service Ratio (GDS) and your Total Debt Service Ratio (TDS). 

 

Gross Debt Service Ratio (GDS) considers your monthly household expenses relative to your gross monthly income. Household expenses include mortgage payments, property taxes, heating costs, and 50% of applicable condominium fees (if applicable). Generally, lenders look for GDS below 32%.

 

To calculate your GDS:

 

GDS = (sum of monthly household expenses/gross monthly income) * 100%

 

EXAMPLE:

 

Todd has a gross monthly income of $7,500. His current mortgage payment is $1,500 per month. His home insurance costs him $100 per month and his property taxes are $250 per month. 

 

Todd’s GDS = ($1,500 + $100 + $250)/($7,500) *100%

= ($1,850)/($7,500) * 100%

= 24.7%

 

Total Debt Service Ratio (TDS) considers how much of a mortgage you can afford given your existing debt. TDS considers whether having a new mortgage will impact your ability to service (pay) your existing debt. Lenders prefer applicants who have TDS ratios below 40%.

 

To calculate your TDS:

 

TDS = (sum of monthly household expenses + existing debt payments)/gross monthly income * 100%

 

EXAMPLE:

 

Mary has a gross monthly income of $9,000. Her current mortgage payment is $2,500 per month. Her home insurance costs $100 per month and her property taxes are $350 per month. She also has a line of credit with a monthly payment of $500 per month.

 

Mary’s TDS = ($2,500 + $100 + $350 + $500)/($9,000) * 100%

= ($3,450)/($9,000) * 100%

= 38.3%

 

A good credit score and down payment, combined with GDS and TDS ratios below 32% and 40% respectively, will make you an attractive borrower to many lenders. 

Interested in gaining more insight into how much you can afford to spend on a home? Check out our Housing Affordability and Mortgage Calculator tools at www.NestandCastle.com

Subheading: Choosing your mortgage type

 

Fixed vs. Variable Rate Mortgages

 

Fixed-Rate Mortgages

Variable Rate Mortgages

Your interest rate and the monthly payment will not change throughout the term of your mortgage agreement Fluctuations in the Prime Rate will not impact you. While this protects you from rising interest rates, you also will not benefit from lower interest rate environments. Typically has a higher interest rate than a variable rate mortgage (at the time the mortgage terms and conditions are negotiated)

Typically have lower interest rates compared to fixed-rate mortgages Fluctuations in the Prime Rate will impact you.  If Prime increases, your interest rate will also increase. This means that more of your mortgage payment will go towards paying interest instead of principal. Your monthly mortgage payment may also increase in the event Prime increases. If Prime decreases, your interest rate will also decrease. This means that more of your mortgage payment will go towards paying principal instead of interest.

 

Open vs Closed Mortgages

 

Closed Mortgages	Open Mortgages
Prepayment of a mortgage outside of the terms and conditions of your mortgage agreement will often result in penalties  Lower interest rates compared to open mortgages A good option if you have no intentions to sell your home or move	Flexibility to pay off your mortgage at any time Ability to move to another lender or lock in a rate at any time Higher interest rates compared to closed mortgages A good option if you think you might sell your home or move shortly

 

Often, you will hear institutions and mortgage brokers refer to mortgages with a combination of the terms described in this section. Now that you know what these terms mean, let’s break down a typical sentence in “mortgage lingo.”  A “5-year variable closed” mortgage means:

Mortgage term: 5 years

Mortgage interest type: Variable rate

Mortgage type: Closed

 

Subheading: Mortgage Programs and Options

 

Mortgage Type/Program	Description
Entrepreneur/Business Owner/Self-Employed	Special mortgage program designed for self-employed individuals who may find it difficult to qualify for conventional mortgages given fluctuations in their annual income
First-Time Homebuyer	First-time homebuyers can benefit from special government programs, including withdrawals from RRSPs to fund down payments
Home Equity Line of Credit	This involves opening a revolving line of credit, secured against your equity in your property A potential option for financing a second property is to open a HELC on your current property and use the proceeds to purchase the second property
Investment Property	Special mortgage program designed for non-owner occupied, investment properties that generate rental income
Longer Amortization	Lower your monthly mortgage payments by increasing the length of your amortization to up to 30 years Not available for mortgages with down payments below 20%
Non-Tier 1/Private	An alternative source of financing for those who may not qualify at institutional lenders (Tier 1 Banks)
Poor/Damaged Credit	Mortgage programs designed for those who have poor or damaged credit, including previous bankruptcies Obtaining a mortgage and making timely payments may help rebuild your credit
Professional	Special mortgage programs available to specific professionals, such as doctors and other healthcare professionals
Purchase + Home Renovation and Improvements	Finance both the cost of your home as well as renovations and repairs Typically rolls the cost of renovations into your mortgage principal
Vacation Property or Second Home	Mortgages designed for recreational properties or secondary homes

 

Mortgage Option	Description
Creditor Insurance	In the event of death, this insurance policy will pay the outstanding balance of your mortgage
Disability Insurance	In the event of disability causing an inability to work, this insurance policy will cover your monthly mortgage payments according to the terms and conditions of your insurance policy

 

Subheading: What documents do I need to bring to my appointment? (NEW SECTION)

 

To have a productive meeting with your mortgage broker or financial planner, ensure you bring the following documents with you to your meeting:

• Proof of Employment

A letter from your current employer outlining your position, your employment status (full time, part-time, contract, etc.), your compensation (e.g. salary), and your tenure (i.e. how long you have been employed).

You may also need a more detailed employment history, particularly if your current employment is relatively new.

• Proof of Address

You will need to provide a document that confirms your current address. This could be a recent utility bill, property tax bill, etc. Depending on how long you’ve lived at your current home, you may need to provide address history (i.e. a list of your previous addresses).

• Government Issued Photo ID

You will need to provide an original copy of your government-issued photo ID (the mortgage broker/financial planner will take a photocopy of the document). Government-issued photo ID includes drivers’ licenses, passports, your official photo card (e.g. Ontario Photo Card, etc.)

• Proof of Income

You will need to provide proof of income, such as your most recent tax return.

• Proof of Down Payment

You will need to provide proof of sufficient down payment, confirming both the amount and the source. If the down payment is a gift from your parents or another family member, you and your parents/family member will need to complete a declaration confirming that the down payment is, in fact, a “true” gift, that it does not need to be repaid, and that your parent/family member will not have a financial interest/stake in the property being purchased.

• Proof of Savings/Investments

If you have savings/investments, it is helpful to bring a copy of your statement showing the amounts you have saved/invested.

• Details of Current Debts 

You will need to provide copies of statements for current debts, including student loans, personal lines of credit, car loans and leases, credit card bills, etc.

 

Depending on your unique financial situation, you may need further documentation. Your mortgage broker/financial planner will keep you informed of what documents they need to process your application for a mortgage.