Mortgage Pre-Approval Process
The pre-approval process has quickly become the norm during the home buying process. Whether you are looking to buy a condo or a single-detached home, a pre-approval gives you the power and knowledge to start your search. The pre-approval process is simple, efficient and allows you to determine what you can afford for your mortgage total and monthly payment. With a pre-approval in the pocket, you can start your search with an actual number in mind, which will allow you to compete in this competitive and often frustrating real estate market. So, what is a pre-approval, and how do you go ahead and secure one?
What is a Mortgage Pre-Approval?
A mortgage pre-approval is a commitment from a specific lender to an individual. This commitment includes the total mortgage amount, the term, the interest rate and the maximum purchase price. If you are working with a mortgage broker, they may suggest going for price X and then getting that approval to cover you if you need to bid up to that max price. While if you are working with a lender directly, they may have different suggestions.
It is important to remember that getting a pre-approval does not lock you into a specific lender. The process is free and should be treated like a baseline test for you to find a better deal. Most pre-approvals will last between 120 days to 160 days and will lock you in for a specific interest rate, no matter what the market does. But the best part is if rates go down, the lender will match this new rate. This means that you will be protected if mortgage rates were to rise or fall, and you have a guaranteed rate from that lender. However, from the lender side, this is not a full guarantee. The rates are only guaranteed as long as your finances stay the same between your pre-approval and applying for the actual mortgage.
Why Should You Get Pre-Approved?
There are several reasons why a pre-approval is a good idea in today’s ultra-competitive market. Not only are you getting a guarantee from a lender, but you are getting an idea of how much you can afford while house hunting. Here are a few of the top reasons why you should look to get a pre-approved mortgage.
1. Working with a relator
If you have already touched base with a realtor, you probably have been told to get a pre-approved mortgage. The reason for this is relatively straightforward. Realtors will need to know what your budget will be to secure a home, and without a pre-approval, you might not be able to nail down that budget. A pre-approval gives you this information, as it included max purchase price, which you can then workaround in your home search. It is viable information and will help both you and your realtor have accurate expectations during the home buying process.
2. Securing a rate
If you are concerned about the current market, you may want to secure an interest rate during your real estate hunt. A pre-approved mortgage locks in a mortgage rate so that you are protected, which is essential in times like COVID-19, where the prime rate may rise unexpectedly as the country recovers. The best part, if the interest rates drop, as does your pre-approved rate. So, it is a win-win in terms of securing that lowest rate for up to 160 days.
3. Make your bid more competitive
In Toronto, Hamilton and Ottawa, we see one of the most competitive real estate markets in decades. Homes are on the market for mere days and are getting hundreds of offers from would-be home buyers. This ultra-competitive market means making your bid as attractive as possible is the name of the game. One of the ways to do that is to remove the financing condition on your offer. You can feel a little better about doing this as you have already spoken to a lender for those with pre-approved mortgages. Removing this condition is a risk and should be done only after talking to a mortgage broker and your realtor. However, it can be a difference-maker between winning and losing a bid.
Factors of a Mortgage Pre-Approval
For the vast majority of lenders, four specific factors come into play regarding determining the mortgage amount and the corresponding mortgage rate. Some of this process will depend on the lender, while other parts of the process are governed by law.
Your credit score is a snapshot of your current financial health and considers all of the financial tools you have used in the past and present. Whether you have credit cards or lines of credit, or anything in between, your credit history is based on several factors, including on-time payments and a history of paying off debts in agreement with the lender.
For mortgage pre-approvals, a score between 680-900 is considered good, and you would qualify for a mortgage from a central bank or credit union. This kind of credit score allows you for an A level lender.
A credit score between 600-680 may still let you qualify for an A level lender, but they will look at your file a little more intensely. Your finances will be scrutinized, as will the type of mortgage you are looking at for the mortgage term. If you do not qualify, you will move down to a B level lender. B level lenders are smaller alternative lenders, such as Home Trust or Equitable Trust.
If your credit score is below 600, you will only qualify for these B level lenders. You will struggle to find a great rate and will be paying well above the norm in terms of your mortgage rate until you can prove to both the lender and credit bureau that you can handle long-term financial tools.
Next, your lender will want to see what your down payment is towards the home. Your down payment is essentially a lump sum payment towards the purchase of your home. The minimum down payment in Canada is 5%, but it can be raised to 20%, depending on the purchase price. If you are putting down less than 20%, you will have to get an insured mortgage by law.
An insured mortgage is otherwise called mortgage default insurance and protects the lender if you default on the home. You will need to pay a premium to the insurer, but your pre-approval will take this into account.
For reference, the size of your down payment directly affects how much you can borrow from a bank. Let us run some numbers to showcase this:
If you can put $15,000 down for a home, the maximum your home can cost is $300,000.
One thing to consider is that Canada has particular rules when it comes to minimum down payment. You can check out the specifics here.
However, here is a general rule of thumb:
- If a home is below $500,000, your minimum down payment is 5%
- If a house is between $500,000 and $1,000,000, the first $500,000 would need 5%, and the rest of the total would require a 10% down payment.
- If a home is over $1,000,000, your minimum down payment is 20%.
Debt Service Ratios
Mortgage lenders are governed by specific legislation that requires lenders to calculate the debt ratios of a potential borrower. Two detailed calculations are made based on the borrowers monthly income, expenses and debt.
The gross debt ratio showcases the maximum shelter costs that you can afford as a borrower. The shelter costs include the mortgage payment, condo fees, property tax and utilities. Most mortgage lenders will not surpass a 30% gross debt ratio.
On the other side, the total debt ratio includes your current debt load and the total shelter costs. Your debt consists of any loan payments (student loan, car loan etc.), credit cards, and line of credit payments. Most mortgage lenders will not let you surpass a 40% total debt ratio.
The exact documentation will depend on the lender or mortgage broker you are working with for your mortgage. As well, your documentation that you enter for your pre-approval may differ from what you will have to send in for your actual application. Every mortgage lender will require some documentation to get a mortgage pre-approval. Here are some examples of the standard documents you will need: