Before you begin your real estate buying process, it’s highly recommended to obtain a mortgage pre-approval. This initial step is crucial to avoid searching for properties beyond your financial capacity.
During pre-approval, you'll identify banks willing to finance your home purchase and ascertain the maximum mortgage amount they can provide. This process gives you a clear understanding of your budget and helps you focus your search within realistic financial boundaries.
Interested in learning how to obtain mortgage pre-approval? Find more details below.
What is the purpose of a mortgage pre-approval?
Securing a mortgage pre-approval is essential when beginning your home buying journey. Indeed, this document serves several purposes. Firstly, it acts as a prerequisite for many real estate agents to show you properties, ensuring you focus on homes within your financial means.
Moreover, a mortgage pre-approval enhances your appeal to sellers, especially in competitive markets where multiple buyers are interested in the same property. It communicates to sellers that you are serious and prepared to move forward with the purchase.
Additionally, a pre-approval provides rate security by allowing you to lock in a mortgage rate for a specified period, typically between 30 to 120 days. This protects you from potential rate increases while you search for a home. Importantly, securing a rate does not commit you to finalize the loan; you can still take advantage of a lower rate if one becomes available.
How to get a mortgage pre-approval?
Feeling ready to apply and get pre-approved to find out your borrowing capacity? Here's how.
1. Choose you approach to obtain a mortgage pre-aapprvoal
When seeking a mortgage pre-approval, it's important to recognize there are two main approaches to consider.
The first method involves independently researching mortgage rates offered by various financial institutions and individually applying to each bank. While this process can be laborious, it also carries the risk of negatively impacting your credit if any applications are declined.
Alternatively, you can choose to work with a mortgage broker who will handle rate shopping on your behalf. A mortgage broker possesses deep knowledge of different lenders' criteria and can advise you on which institutions are most suitable given your financial situation. This not only saves time but also increases your chances of securing a mortgage at the best possible rate in a timely manner.
Be careful not to impact your credit rating!
It's important to tread carefully to avoid impacting your credit rating when pursuing mortgage pre-approval independently. In Canada, banks are mandated to report any refusals, which can potentially lower your credit score.
If all lenders approve your pre-approval application, your credit score remains unaffected. However, refusals from one or more lenders can leave a negative mark on your credit file.
On the contrary, using a mortgage broker can help mitigate this risk. Brokers typically provide lenders with your banking information rather than your personal identity details. Therefore, even if there are refusals during the pre-approval process, there will be no impact on your credit file.
2. Complete the application form
The next step involves filling out the mortgage pre-approval application, which can be done either through your broker or directly with a financial institution.
During this process, you'll be required to submit various documents that confirm:
- Your identity.
- Your credit score, which typically ranges from 300 to 900 and reflects your creditworthiness.
- Your financial situation, including details about your employment status, overall financial health, and existing debts.
- Your down payment amount, which represents the initial sum you’ll contribute towards the mortgage.
It's worth noting that a larger down payment can lead to significant savings in interest over the life of the mortgage. In Canada, the minimum down payment required is 5% of the purchase price. For example, on a property priced at $400,000, this would amount to $20,000.
To avoid having to pay mortgage insurance, a down payment of at least 20% of the purchase price is necessary. Using the same $400,000 property as an example, this would equal $80,000.
3. Calculating your debt ratio
Calculating your debt ratio is essential when applying for a mortgage, as it evaluates your ability to make repayments based on:
- Your gross monthly income before taxes and deductions.
- Monthly housing costs, which includes mortgage or rent, heating, electricity, home insurance, condo fees, and applicable taxes .
- Monthly payments for any car loans or leases .
- Other monthly expenses related to additional financial obligations such as student loans, furniture or appliance financing, and child support.
It's important to note that certain expenses such as food, phone bills, or transportation costs are not typically factored into your debt ratio for a mortgage application. However, considering these expenses is advisable to gain a comprehensive understanding of your overall budget commitments.
Additionally, your mortgage broker can offer detailed guidance on all expenses associated with your home purchase, both before and after finalizing the deed of sale.
Let's see an example to calculate debt ratio:
Consider a couple with a gross monthly income of $4000. Their monthly expenses include:
- Rent: $800
- Car payments: $200
- Student loan repayments: $200
In this scenario, their debt ratio would be approximately 30%, which is generally considered favourable. This percentage, often referred to as the Total Debt Service Ratio (TDS), should typically not exceed 40%. Exceeding this threshold could potentially impact their ability to pursue their plans for real estate purchase.
4. Confirming your borrowing capacity and submitting your application
Confirming your borrowing capacity and submitting your mortgage application entails a thorough evaluation of your financial situation. This assessment takes into account key factors such as:
- Your income
- Rent or mortgage payments
- Credit rating
- Existing debts
- Down payment amount
Using this information, your mortgage broker can determine the maximum amount you may be eligible to borrow for a mortgage. They will then assist you in identifying financial institutions where your application stands a strong chance of approval. Leveraging their expertise, they aim to optimize your chances of securing a favourable outcome.
5. Get pre-approved... or not
Next, you'll reach the pivotal moment of finding out which banks are willing to provide you with a mortgage and the potential loan amount they may approve. It's essential to remember that each lender sets its own criteria and policies for mortgage approvals. Therefore, there's no guarantee that any bank will be obligated to lend you money.
If your mortgage pre-approval is denied due to reasons such as a poor credit history or unfavourable debt ratio, our broker can discuss alternative strategies with you:
1. Adjust the purchase amount by considering less expensive properties.
2. Increase your down payment to enhance your borrowing capacity.
3. Consider involving a co-signer who can provide additional financial support.
4. Explore alternative lenders who might consider your application, potentially at a higher mortgage rate due to perceived risks.
It's important to understand that receiving a mortgage pre-approval does not guarantee final approval. Various factors, such as unexpected life events or changes in financial circumstances, can impact or negate a previously favourable pre-approval decision.
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